Published: December 20th, 2023
An analysis by Deutsche Bank suggests Sterling could sink against the Euro to levels last seen during the mini-crisis caused by former Prime Minister Liz Truss’ and her disastrous budget of September 2022.
The bank’s analysts believe a cooling UK economy could prompt the Bank of England to cut interest rates in May, leading to a decline in the Pound’s value.
In a report published this week, Deutsche said the expected speed and timing of the transition from hiking to cutting for G10 central banks ‘will be a significant influencer over their respective currencies next year.’
Under that scenario, Sterling will be disadvantaged by BoE policymakers, who Deutsche believes will cut the Bank Rate in May, even before the US Federal Reserve and European Central Bank make similar moves, closer to mid-year 2024.
'The monetary policy tightening undertaken this year is beginning to cascade through the UK economy,’ Deutsche’s report says. ‘Housing prices are beginning to move into correction territory, but could fall further. The reduction in real estate activity hasn’t impacted labour markets yet. When it does the signs of economic slowdown will become clear very quickly.’
The Bank's base case is that Threadneedle Street will begin cutting rates in the Spring of 2024. Washington and Frankfurt are expected to start their easing cycles closer to mid-year.
The analysis also rates the UK’s balance of trade to be in a poor place, with external accounts turning negative again. Based on that, Deutsche is forecasting a Pound to Euro exchange rate of 1.11 and 1.0870 by mid-year.
The last time the pair’s rate fell to that level was when former Prime Minister Liz Truss delivered an unfunded budget that caused currency investors to panic and mass-liquidate their GBP holdings.
At the start of 2023, Barclays was calling GBP/EUR a buy on predictions of a hawkish reset by Bank of England policymakers.
The bank’s analysts believed a stronger UK economy and progress in negotiations with Brussels over the Northern Ireland protocol pointed to potential gains for Sterling over its continental cousin.
In a research note published on Monday 23rd January, Barclays said ‘trends in domestic inflation, strong growth, an expected hawkish turn by the (BoE) Monetary Policy Committee, plus more constructive tone from negotiations with the EU bode well for the Pound ahead of February’s bank meeting'.
The call came after a stretch of underperformance for GBP that placed it at the bottom of the G10 major currencies list over most of December 2022.
Barclays blamed the BoE for Sterling’s underperformance, due to raising interest rates by 50 basis points in December 2022 while warning of downside economic risks and signaling that it may need to slow the pace of interest rate rises.
Threadneedle Street regularly disappointed forex traders last year by delivering smaller-than-expected rate hikes and consistently gloomy economic forecasts.
Barclays did note that Britain’s economy was turning out to be more resilient than the Bank believed it would in August and November, something that would be adjusted for in the next set of economic forecasts.
'Rising demand and inflation sparked a hawkish shift amongst the MPC’s core membership in December,’ said Barclays. 'That strongly suggests that February’s meeting is being underpriced by traders.’
As 2022 wound down in November, Sterling posted a strong recovery as price action suggested the Pound was being pushed up by global factors.
Analysts, however, said Britain’s domestic outlook ‘remain(ed) challenging’ and GBP’s gains might not be sustainable.
Despite those concerns the Pound was the best-performing major currency in the first week of November 2022, as global markets extended a rally from the previous week and gave the UK currency space to recover some of the losses suffered following last Bank of England meeting.
‘If risk sentiment holds then we should see modest Sterling gains through to year-end,’ wrote Barclays currency analysts in a market commentary.
Global stock markets were up in early November and stayed there at the start of this week Monday as investors bet China was preparing to end its zero-Covid policy. Economists believe such a move could give the faltering global economy a much-needed kick and provide risk-sensitive currencies like GBP a welcome nudge.
The Bank of England raised interest rates by 75 basis points on 3rd November but cautioned that rates were unlikely to go as high as the ca. 5.25 per cent investors were watching for ahead of the announcement.
Sterling made a strong start to 2022 in January and February thanks to an after-Omicron economic rebound, plus expectations at the time that the BOE was readying new interest rate hikes.
Numbers from the Office of National Statistics (ONS) showed that retail sales lifted by nearly two per cent month-on-month in January, beating consensus forecasts of one per cent and leaping ahead of December's negative four per cent reading.
In a market analysis published the week of February 21st, ING's FX Strategy Unit said that UK retail sales came back in January with a vengeance as the Omicron worries began to dissipate. 'Sterling now looks relatively less exposed than to adverse swings in geopolitical sentiment than the Euro and Nordic currencies like Swedish Krona.’
ONS data also shows commuter travel in Britain's most significant cities bouncing back to pre-Omicron levels, supporting expectations that February will be remembered as the start of a solid rebound in growth.
ING said the latest bus, train and mobility numbers also showed that offices and services in central London are now about as busy as they were before Omicron.
The figures came after Westminster announced the end of all Covid-19 related restrictions in England, even eliminating the strict testing measures that had been in place for travel, after determining that Omicron is much less deadly than earlier waves of coronavirus.