The Pound to Dollar (GBP/USD) exchange rate hit 12-month highs at 1.2675 on May 10th before a retreat to 1.2400 amid a dollar rebound.
The Pound to Euro (GBP/EUR) exchange rate also hit 2023 highs close to 1.1550 before settling just above 1.1500.
Pound Sterling: UK Outlook Half Full or Half Empty
The UK fundamentals have improved over the past few months with an important boost from lower energy prices.
Markets assume that the UK government is now embracing convention policies, increasing the importance of monetary policies.
The latest UK GfK consumer confidence data recorded a further improvement to a 15-month high.
Although the PMI data records a further contraction, there has been further expansion in services.
The Bank of England now forecasts limited growth for 2023 and 2024 and abandoned its call of a shallow and extended recession.
According to HSBC; “We no longer see a recession, and are now forecasting a rise of 0.4% in GDP in 2023. While this looks very poor compared with 2022’s 4.1%, in fact, it’s an acceleration.”
The UK economy has, however, continued to under-perform in global terms. GDP is still 0.5% below the pre-covid peak and the worst performance in the G10 area.
According to Rabobank; “It is our view that GBP’s gains since early March suggest that a lot of better news regarding UK fundamentals is already baked into the price.
It added; “However, there is a strong distinction between ‘better’ and ‘strong’ fundamentals, and the UK continues to fall significantly short of the latter measure.
According to MUFG; “UK Economic resilience helped by the improved energy terms of trade will help provide support and improve the UK’s trade and fiscal position which will further help provide support for the pound.”
Bank of England Watching Inflation Very Closely
The Bank of England (BoE) increased interest rates by a further 25 basis points to 4.50% at the May policy meeting.
The headline inflation rate will inevitably decline sharply in the short term, primarily due to base effects.
The latest inflation data will be published on May 24th. Consensus forecasts are for the headline rate to decline to 8.2% from 10.1% due to the fact that prices surged last April due to the increases in energy prices.
The core rate is expected to be more stubborn with a small decline to 6.1% from 6.2%.
The Bank of England is concerned that underlying inflation pressures will persist and potentially force further interest rate hikes.
According to ING; “We continue to think that further tightening is unlikely. Wage disinflation can allow the BoE to pause at its 22 June meeting.”
Goldman Sachs is more positive surrounding the Pound and more hawkish surrounding the BoE.
It notes; “Despite being vulnerable to further bouts of risk-off, we remain constructive on Sterling, especially after the latest BoE meeting.
Goldman adds; “While the Bank’s significant forecast upgrades to growth and inflation present a higher bar for the incoming data to beat, it also reflects the risk of higher inflation persistence that would require additional monetary policy tightening.
Goldman expects that the BoE will raise rates to 5.0%.
BNPP expects the medium-term BoE stance will be more dovish; “We remain of the view that the BoE will begin easing through Q1 2024, and at 3.5% we have a significantly lower end-2024 expectation on Bank Rate than the market (around 42bp higher). This adds to our view that there is a hawkish mispricing, especially as we move into the first quarter of next year.”
To some extent, the BoE is caught in the middle of the ECB and Federal Reserve inflation battles.
According to BNPP; “The ECB is the most hawkish in that it has retained a clear bias for further tightening. The Fed, by contrast, has more explicitly signalled a bias to pause. We think the BoE has a bias to tighten further, but it is by no means explicit.”
ECB Committed to Inflation Fight
The ECB increased interest rates by a further 25 basis points at the May meeting with the refi rate at 3.75%.
The bank remains committed to battling inflation but has not provided guidance on further rate hikes.
Nordea expects that the ECB will maintain a hawkish stance; “The economy has been holding up relatively well, the labour market remains hot and with services inflation still accelerating in April, the ECB is lacking evidence of inflation returning to target in a timely manner. We think the ECB will hike rates by 25bp in both June and July.”
Nordea expects that GBP/EUR will weaken to 1.11 at the end of 2023 with a further slide to 1.08 at the end of 2024.
Lower Gas Prices still Euro Positive
MUFG notes; “After a period of strong outperformance, cyclical stocks are now underperforming again. Is this a reflection of bad news emerging or more a reflection of excessive optimism correcting back to a more realistic level?
The bank points to a further decline in gas prices with European prices trading close to 2-year lows.
In this context, it adds; “For now we would be in the latter camp with no real deterioration in the data or news flow to warrant a reassessment of the outlook.”
MUFG expects lower energy prices will support the UK and Euro-Zone outlooks. In this context, it has an end-2023 GBP/EUR forecast of 1.14.
Danske Bank expects that GBP/EUR will trade in a 1.14-1.15 range for much of the time due to similar fundamentals.
Federal Reserve Stance Crucial
The Federal Reserve increased interest rates by a further 25 basis points to 5.25% at the May policy meeting.
The central bank did adjust its rhetoric and suggested that there may be a pause at the June meeting to assess developments.
The Fed has consistently stated that interest rates are not expected to be cut this year.
There is an important divergence in investment bank interest rate forecasts.
Danske Bank expects that the Fed will not cut rates and that tighter financial conditions will underpin the dollar.
It adds; “In line with market expectations, we think the Fed has delivered its last rate hike for this hiking cycle. However, we think the current 65bp of rate cuts priced for the rest of the year is too aggressive.”
ING, however, expects the economy will deteriorate more sharply over the second half of the year and this will force the Fed to cut rates more aggressively.
The bank expects that the Fed will cut interest rates by 100 basis points by the end of 2023.
These interest rate expectations are crucial in determining dollar forecasts and the GBP/USD outlook.
According to ING; “Based on our overall dollar view, GBP/USD should be heading higher this year. 1.33 is our target for year-end.”
Danske Bank, however, expects the Federal Reserve stance and tightening financial conditions will undermine the Pound.
It has a 6-month GBP/USD forecast of 1.20 and a 12-month forecast of 1.17.
Rabobank has a 3-month GBP/USD forecast of 1.22.
The Pound to Euro (GBP/EUR) exchange rate also hit 2023 highs close to 1.1550 before settling just above 1.1500.
Pound Sterling: UK Outlook Half Full or Half Empty
The UK fundamentals have improved over the past few months with an important boost from lower energy prices.
Markets assume that the UK government is now embracing convention policies, increasing the importance of monetary policies.
The latest UK GfK consumer confidence data recorded a further improvement to a 15-month high.
Although the PMI data records a further contraction, there has been further expansion in services.
The Bank of England now forecasts limited growth for 2023 and 2024 and abandoned its call of a shallow and extended recession.
According to HSBC; “We no longer see a recession, and are now forecasting a rise of 0.4% in GDP in 2023. While this looks very poor compared with 2022’s 4.1%, in fact, it’s an acceleration.”
The UK economy has, however, continued to under-perform in global terms. GDP is still 0.5% below the pre-covid peak and the worst performance in the G10 area.
According to Rabobank; “It is our view that GBP’s gains since early March suggest that a lot of better news regarding UK fundamentals is already baked into the price.
It added; “However, there is a strong distinction between ‘better’ and ‘strong’ fundamentals, and the UK continues to fall significantly short of the latter measure.
According to MUFG; “UK Economic resilience helped by the improved energy terms of trade will help provide support and improve the UK’s trade and fiscal position which will further help provide support for the pound.”
Bank of England Watching Inflation Very Closely
The Bank of England (BoE) increased interest rates by a further 25 basis points to 4.50% at the May policy meeting.
The headline inflation rate will inevitably decline sharply in the short term, primarily due to base effects.
The latest inflation data will be published on May 24th. Consensus forecasts are for the headline rate to decline to 8.2% from 10.1% due to the fact that prices surged last April due to the increases in energy prices.
The core rate is expected to be more stubborn with a small decline to 6.1% from 6.2%.
The Bank of England is concerned that underlying inflation pressures will persist and potentially force further interest rate hikes.
According to ING; “We continue to think that further tightening is unlikely. Wage disinflation can allow the BoE to pause at its 22 June meeting.”
Goldman Sachs is more positive surrounding the Pound and more hawkish surrounding the BoE.
It notes; “Despite being vulnerable to further bouts of risk-off, we remain constructive on Sterling, especially after the latest BoE meeting.
Goldman adds; “While the Bank’s significant forecast upgrades to growth and inflation present a higher bar for the incoming data to beat, it also reflects the risk of higher inflation persistence that would require additional monetary policy tightening.
Goldman expects that the BoE will raise rates to 5.0%.
BNPP expects the medium-term BoE stance will be more dovish; “We remain of the view that the BoE will begin easing through Q1 2024, and at 3.5% we have a significantly lower end-2024 expectation on Bank Rate than the market (around 42bp higher). This adds to our view that there is a hawkish mispricing, especially as we move into the first quarter of next year.”
To some extent, the BoE is caught in the middle of the ECB and Federal Reserve inflation battles.
According to BNPP; “The ECB is the most hawkish in that it has retained a clear bias for further tightening. The Fed, by contrast, has more explicitly signalled a bias to pause. We think the BoE has a bias to tighten further, but it is by no means explicit.”
ECB Committed to Inflation Fight
The ECB increased interest rates by a further 25 basis points at the May meeting with the refi rate at 3.75%.
The bank remains committed to battling inflation but has not provided guidance on further rate hikes.
Nordea expects that the ECB will maintain a hawkish stance; “The economy has been holding up relatively well, the labour market remains hot and with services inflation still accelerating in April, the ECB is lacking evidence of inflation returning to target in a timely manner. We think the ECB will hike rates by 25bp in both June and July.”
Nordea expects that GBP/EUR will weaken to 1.11 at the end of 2023 with a further slide to 1.08 at the end of 2024.
Lower Gas Prices still Euro Positive
MUFG notes; “After a period of strong outperformance, cyclical stocks are now underperforming again. Is this a reflection of bad news emerging or more a reflection of excessive optimism correcting back to a more realistic level?
The bank points to a further decline in gas prices with European prices trading close to 2-year lows.
In this context, it adds; “For now we would be in the latter camp with no real deterioration in the data or news flow to warrant a reassessment of the outlook.”
MUFG expects lower energy prices will support the UK and Euro-Zone outlooks. In this context, it has an end-2023 GBP/EUR forecast of 1.14.
Danske Bank expects that GBP/EUR will trade in a 1.14-1.15 range for much of the time due to similar fundamentals.
Federal Reserve Stance Crucial
The Federal Reserve increased interest rates by a further 25 basis points to 5.25% at the May policy meeting.
The central bank did adjust its rhetoric and suggested that there may be a pause at the June meeting to assess developments.
The Fed has consistently stated that interest rates are not expected to be cut this year.
There is an important divergence in investment bank interest rate forecasts.
Danske Bank expects that the Fed will not cut rates and that tighter financial conditions will underpin the dollar.
It adds; “In line with market expectations, we think the Fed has delivered its last rate hike for this hiking cycle. However, we think the current 65bp of rate cuts priced for the rest of the year is too aggressive.”
ING, however, expects the economy will deteriorate more sharply over the second half of the year and this will force the Fed to cut rates more aggressively.
The bank expects that the Fed will cut interest rates by 100 basis points by the end of 2023.
These interest rate expectations are crucial in determining dollar forecasts and the GBP/USD outlook.
According to ING; “Based on our overall dollar view, GBP/USD should be heading higher this year. 1.33 is our target for year-end.”
Danske Bank, however, expects the Federal Reserve stance and tightening financial conditions will undermine the Pound.
It has a 6-month GBP/USD forecast of 1.20 and a 12-month forecast of 1.17.
Rabobank has a 3-month GBP/USD forecast of 1.22.