Published: February 28th, 2024
Bank of America has revised its forecasts upward for the British Pound, saying Sterling can benefit from its new role as Europe’s equivalent of the Greenback.
BofA's currency strategy unit published a note to investors this week saying strong labor prints and improving fundamentals mean the Bank of England will be able to hold rates for 5.25 per cent longer than other central banks, ensuring GBP gets a lift from positive carry.
'Carry' occurs when forex traders borrow using a low interest rate currency to fund a position in a higher interest rate currency, placing the higher rate currency in bid. Forex traders have relied heavily on carry since central banks started raising rates to manage growing inflation, a trend that shows no signs of abating as rates come down.
BofA sparked a flurry of comment in early 2022 when it described Sterling’s post-Brexit behavior as reminiscent of an emerging market currency. This week its analysts made another novel comparison, suggesting GBP could be acting like ‘Europe’s USD’.
‘Driving factors in America can also be applied to the United Kingdom as both countries are dealing with the adverse effects of tight labor markets and elevated services inflation,’ wrote BofA analysts.
The Pound and the Greenback have both performed well this year as forex traders began walking back expectations for the number of interest rate cuts from Threadneedle Street and The Fed, suggesting that investor believe what's good for the Dollar is good for Sterling too.
In foreshadowing of BofA's analysis, one of the UK’s biggest High Street Banks said the Bank of England (BoE) would likely leave interest rates unchanged until at least 2025.
Elevated wage growth will keep inflation uncomfortably high for BoE policymakers, said HSBC in November 2023. Bank analysts said the BoE had signaled a determination to pull price rises back down to its two per cent target.
‘Given high wage growth and no subsequent rise in productivity, services firms in particular may have to pass on rising costs to customers,’ said an analyst note from HSBC’s Economics Unit in London.
‘Core inflation is sticky and wage growth is a key driver,’ the note said, ‘so we expect the BoE to hold the course across 2024.’
HSBC’s forecast went against the grain of market consensus, which was looking for new rate cuts to start around mid-2024. Institutional analysts echoed the mainstream economist expectation and looked for new rate cuts in this timeframe.
A few economists believed rate cuts migh arrive even earlier, by May 2024 if economic slowdown and a rapid decline in inflation pushed the BoE to be more supportive of growth through interest rate reductions.
In one interesting development, the Bank of England's Chief Economist diverged from the majority of Monetary Policy Committee members, saying that the market's current expectation for rate cuts to start on or about June 2024 was probably correct.
HSBC said that despite a recent fall in UK inflation, it remained high compared to many of Europe’s large economies. That was putting pressure on the Bank to keep rates on hold for most of 2024.
Falling energy prices will make inflation's path from eleven per cent to four per cent simpler than the journey from four per cent to two per cent.
‘Given that reality, we think BoE policymakers will stay the course longer than the market currently expects’.
In June 2023, forex traders were raising their speculative bets on the Pound, believing it was set to strengthen amid rising positive sentiment.
Data published by the US Commodity Futures Trading Commission (CFTC) showed that bullish positions on GBP rose by USD 3.2 billion in the seven days leading up to Wednesday, 21st June.
There was significant growth in 'long' contracts, with 37,110 new positions indicating growing optimism in the UK currency's prospects.
A ‘long’ position means a trader opens a contract based on a presumed future rise in the price of an underlying asset, in this case the asset being Pounds Sterling.
Analysts at MUFG told Bloomberg that speculative traders had ‘aggressively pursed net-GBP longs’ over the past fortnight. The boost created the biggest net long position on GBP held by Leveraged Funds since September of 2022.
For the seven-day trend noted in the CFTC’s report, it was the biggest one-week jump seen since April 2016. But MUFG analysts said the cumulative net GBP long was the biggest since 2014.
‘Traders have been slowly leaning into Sterling since April, but the jump seen last week is very significant.’
The surge in bullish Pound positions reflected a growing consensus among leveraged fund investors that the Bank of England’s shift to aggressive monetary tightening would have a positive effect on the currency.
Threadneedle Street surprised investors the previous week by raising interest rates 50 basis points, a big leap from the successive 25bp hikes seen before.
Traders started looking for Britain’s base rate to settle at or above six per cent, meaning the UK would have the highest rate amongst G10 countries.
In October last year, UK house prices were on track for a strong rebound in 2024 thanks to improving household balance sheets and a forecast drop in mortgage costs.
But amid the upbeat outlook, a report from Pantheon Macroeconomics cautioned that house prices could fall further over the coming six months as interest rates remained elevated.
‘We still believe house prices will fall by around six per cent from peak-to-trough, with the low-point arriving sometime in April," the report said.
Figures from the UK Office of National Statistics (ONS) showed that UK house prices actually rose in August 2023. Pantheon said this underlined the extended resilience in the housing market. Despite that apparent strength, the affordability of mortgage finance was hit by rising interest rates.
