Pound sterling digs in against USD on UK rate outlook

UK interest rate outlook supports pound sterling against dollar

On Monday, the British pound remained stable against the U.S. dollar but slightly weakened against the euro after two consecutive days of gains, as investors assessed the likelihood of interest rates in Britain remaining higher than in other major economies throughout 2024.

The Bank of England (BoE) last week pushed back against market expectations of a first interest rate cut by May. Although a rate cut in June is now fully priced in, the central bank's pushback has led to some steadiness in the pound's value.

Recent data from the U.S. financial markets regulator indicates that large speculators have increased their bullish positions in the pound, reaching the highest net long position (betting on sterling's value rising) in about three months.

At the time of writing on Monday, the GBP to USD exchange rate is holding at $1.2667, while the EURGBP rate is at 86.19 pence, indicating sterling is down 0.34% against the euro on the day.

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UK interest rates: BoE expected to proceed with cuts at a more measured pace

Market expectations suggest a significant probability of rate cuts by the European Central Bank (ECB) and the U.S. Federal Reserve as early as March, with cuts fully priced in by May. The Bank of England, however, is expected to proceed with rate cuts at a more measured pace. The UK rate futures market has priced in approximately 80 basis points (bps) of cuts for 2024, while the euro zone and U.S. derivatives markets have priced in 150 bps.

Inflation in the UK has notably proven more persistent compared to the euro zone and the United States. Core inflation, excluding food and energy prices, stands at 5.7% in Britain — higher than the 3.6% recorded in the euro area and 4% in the United States.

Despite the UK economy experiencing stagnation, it has managed to avoid recession thus far. Recent data on business activity showed an unexpected uptick in growth and a slight deceleration in price pressures in the services sector in early December.

The prevailing expectation that UK interest rates will need to remain elevated for a more extended period compared to other countries has supported the pound throughout the year. Sterling has been one of the strongest-performing G10 currencies against the dollar in 2023, registering a gain of about 5%, ranking second only to the Swiss franc, which has seen a 6% increase.

GBP forecast: Scotiabank sees cable supported at 1.2600, Nomura says sterling’s rise will be “modest”

In a GBP forecast issued on Monday, Shaun Osborne, Chief Currency Strategist at Scotiabank, said that the pound to dollar rate — widely known as “cable” in forex markets — should find support in the 1.2600 area going forward, despite corrective losses in the short run:

“The GBP/USD pair traded positively overall last week but late week losses off the 1.2794 high are extending so far today and more corrective losses may be in order in the short run.

Cable should find support on dips to the 1.2600/1.2620 area, however, with short, medium and long-term trend signals still aligned bullishly despite losses since Friday’s peak”.

In a more long-term GBP forecast, analysts at Tokyo-based Nomura said sterling’s rise will be modest. A research note issued on December 15 read that the bank sees GBPUSD at 1.28 by Q2 2024:

“Stronger GBP was no doubt led by the BoE’s announcement; however, the softening in USD has been the driver over the past few sessions. The market has continued to unwind its long USD exposure.

We believe this softer USD trend will become more apparent going forward, and this will help raise GBP/USD. That said, we do not expect economic growth in the UK for the next few quarters to be as resilient as in the US, and as a result, sluggish growth in the UK is likely to be a drag on GBP. Therefore, on net, we think the rise in GBP/USD will be modest and expect 1.27 and 1.28 in Q1 and Q2 2024, respectively”.

Euro to GBP forecast: ING sees euro to pound rate retesting 0.8550 by end of 2023

In a euro to GBP forecast issued as part of ING’s FX Daily series on Monday, forex analyst Francesco Pesole wrote that EURGBP could favour sterling in the coming weeks, retesting the 0.8550 level by year-end:

“Markets are still pricing in four rate cuts by the Bank of England this week despite the Bank’s attempt to discourage dovish bets via in-meeting communication. We still think services inflation in the UK will ease to around 4% by next summer, allowing the BoE to start cutting, but the pound has decent room to benefit from some hawkish repricing in the short run. Last week’s 0.8550 lows in EUR/GBP may well be retested by the end of December”.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.