The outlook for the pound looks “gloomy” as the Bank of England faces a series of unique challenges, according to a new note from Bank of America.
Bank of America senior FX strategist Kamal Sharma said he expects further weakness in the pound for the remainder of 2022, following losses against the euro and dollar this year, particularly during of the last six weeks.
“Rising rates in the face of a sharply slowing economy is never a good idea for a currency,” Sharma said, adding that the UK’s net international investment position (NIIP) had deteriorated, that Brexit was still imminent and investors were talking more and more about the pound sterling. “[emerging market] characteristics”.
rise of the euro
The Bank of England (BoE) has raised interest rates four times since December, starting its monetary tightening ahead of other major central banks, including the European Central Bank (ECB).
Even so, Sharma continued: “An easing of the current risk aversion environment and fiscal stimulus could provide some relief, but the damage has been done and the outlook for the pound looks bleak. Our preferred expression remains higher EUR/GBP.
The Bank of England warned earlier this month that the UK economy would fall into recession this year.
High-beta, commodity-linked currencies have rallied against the safe-haven dollar in recent weeks, the greenback as equity selling showed signs of slowing and Fed rate hikes appeared fully priced in.
Meanwhile, the ECB all but confirmed an upcoming rate hike, with an end to negative interest rates by the end of the third quarter.
Data released today showed eurozone inflation hit a record high of 8.1%.
sterling sensitivity
Jane Foley, head of FX strategy at Rabobank, told Capital.com: “The UK running a current account deficit arguably increases the pound’s sensitivity to bad news, especially as many international investors have never understood Brexit and see it as an added factor to the high inflation/lower growth dynamics in the UK.
Rabobank’s three-month forecast, Foley said, was EUR/GBP at 0.86, down from 0.85 currently.
“Although the pound pushed back its lows against the euro this month on the back of strong UK employment data and high CPI inflation, concerns over UK growth United provide a strong headwind to the pound,” she explained.
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No Coming Collapse
ING analysts also noted the ‘downtrend around the British pound’ today and said they were looking for EUR/GBP at 0.86, but trading within a volatile 0.8450 range. -0.8550 at the moment.
“The argument is that rising rates in a slowing economy is negative for the pound. And it’s true, the pound has recently taken on the characteristics of a growth currency, being driven more by equities than by rate differentials over the past few months,” they said.
“But we think much of the weakness is a reflection of general dollar strength, and we’re not looking for a collapse in sterling.”
Upcoming rate decision
Shaun Osborne and Juan Manuel Herrera, analysts at Scotiabank of Canada, said the USD’s broad tone would likely spearhead the pound until the Bank of England’s policy decision on June 16.
“Markets are pricing around a one in four chance of a 25bps hike while still expecting five 25bps hikes in the remaining five meetings this year, which we think is excessive given the UK cost of living crisis and an economic slowdown that would be made worse by aggressive BoE tightening,” they argued.
“The upside of the GBP therefore appears limited, unless there are clear signs in the coming months that the UK economy – household consumption in particular – has not been so severely impacted by the high costs of energy and BoE rises than feared.”
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