This year’s British pound’s weakness surprised many market participants. A strong dollar may explain the GBP/USD exchange rate drop, but the pound remains weak across the board.
To get a better perspective, I spoke to, Giles Coghlan, Chief Market Analyst at HYCM, to find out his view on the pound, the Bank of England’s monetary policy, and what may lie in the months ahead.
Invezz (IZ): The Bank of England has recently forecast a prolonged recession and a rise in unemployment. Yet, it is still planning to raise the Bank Rate to fight inflation. In your opinion, at what level will the bank rate peak?
Giles Coghlan (GC): Answering that question now, about the future, is tricky as the Bank will be responding to incoming growth and inflation data which we haven’t seen yet. However, Short Term Interest Rate Markets (STIR) are forecasting a peak rate of 4.25% – I think this is far too aggressive. At their last meeting in August, the BoE said that market-implied expectations for the path of Bank Rate had fallen since the MPC’s previous meeting, now peaking at just under 3% in March 2023. This path has continued to be higher than the BoE are expecting, so I think a peak somewhere around 2.5% seems reasonable if current conditions remain the same.
Invezz (IZ): GBP/USD traded recently at the lowest level since 1985. Where do you see the exchange rate heading by the end of the year? What can we expect in 2023?
Giles Coghlan (GC): Once the Federal Reserve starts slowing their path of rate hikes, then cable can recover – a return to 1.2800 seems reasonable as things stand. If US CPI prints below 7.8% for the headline y/y print on Tuesday September the 13th that could give the GBP/USD a nice little boost higher. However, if the conflict between Russia and Ukraine fades, then I would expect cable to outperform that and move above 1.3000. Remember, the USD has been sharply gaining not only on Fed expectations, but also safe haven flows. As a result of the turbulent geopolitical landscape in Europe, many investors are seeking safety in the greenback.
Invezz (IZ): As a follow-up question – do you believe that there are more dollar-specific factors at work that weigh on the GBP/USD exchange rate, or does the relationship between money supply and inflation in the UK have a bigger impact?
Giles Coghlan (GC): The GBP weakness has mainly been a result of USD strength and the Russia/Ukraine crisis. Look at the reaction on an index-based chart of the EUR and the GBP when Russia sent troops into Ukraine. It was clearly proximity risk that hit both the GBP and the EUR. So, think of it like this – Number 1, USD strength hit the GBP (and all the other major pairs). Number 2, the conflict between Russia and Ukraine began to weigh on the GBP. Number 3, the Bank of England’s projection of a looming recession has affected the exchange rate – see this article here written at the time.
Invezz (IZ): What impact will Brexit have on the FX market? It seems this has been overlooked amid other events i.e. Ukraine war, soaring inflation, concerning energy market heading into winter, etc.
Giles Coghlan (GC): To the extent that it drags on growth, Brexit will continue to gently weigh on the GBP. There are still many uncertainties surrounding the UK’s departure from the European Union, and it remains a risk for the GBP going forward. The Northern Ireland border issue continues to drag on sentiment.
Invezz (IZ): Bearish sentiment on Europe and EUR is one of the main themes in the FX market this year. Yet, even in this context, triggered mainly by high energy prices and the war in Ukraine, the euro is stronger than the pound this year. Why do you think that is?
Giles Coghlan (GC): Although the Bank of England has projected that the UK is set to head into a recession for 15 months from Q4 2022, when the European Central Bank met last week, it still expects positive GDP growth as its base case. You can read the ECB statement here, which demonstrates expectations that the economy to grow by 3.1% in 2022, 0.9% in 2023, and 1.9% in 2024.
Giles Coghlan is Chief Market Analyst, HYCM – an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders. HYCM is regulated by the internationally recognized financial regulator FCA. HYCM is a global brand name of the HYCM Capital Markets Group. The Group via its relevant subsidiaries has representations in Hong Kong, United Kingdom, Dubai, and Cyprus.
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