BoFA says Pound Sterling's Strong Run against Euro, Dollar Set to Unravel

"GBP is in the process of yet another post-war reset in the aftermath of the Brexit Referendum" - Kamal Sharma, Bank of America.

Above: Bank of America, Canary Wharf, London. Image © Adobe Stock.

The British Pound is one of the strongest performers of 2022 but foreign exchange strategists at Bank of America say the UK currency will struggle in 2022, due to Brexit and a list of other issues.

The Pound has this week rallied to new two-year highs against the Euro and stayed within reach of multi-week highs against the Dollar, helped by a string of consensus beating economic data.

The ONS this week reported inflation is running at 30-year highs and unemployment continues to fall, but for Bank of America the economy will struggle over coming months.

Kamal Sharma, FX Strategist at Bank of America, says the Pound will therefore be subject to "a smorgasbord of negatives in 2022".

In fact, Sharma believes the strong start to 2022 is not even built on fundamentals, but rather it is a technical repositioning amongst market participants.

"Sterling's 2021 sweet spot lasted for all of one quarter before settling into a range for the rest of the year," says Sharma. "The start of 2022 has seen similar strong performance but for different reasons, specifically a positioning squeeze."

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The market entered 2022 holding a consensus 'short' on the Pound; i.e. the plurality of market participants were engaged in bets that would deliver profit were the Pound to fall.

But an interest rate rise by the Bank of England in December surprised a market that expected no change, prompting a counter-trend move higher in the Pound that washed away any vestiges of crowded positioning to the short side of Sterling.

But looking ahead, Sharma says, "GBP is not the blank canvass it was last year: expectations were low, positive surprises and relief were high and investment flows returned."

"The peak of the cycle has now passed in our view as UK growth slows in both absolute and relative terms and the UK rates markets price in a very proactive Bank of England," he says.

The Bank of England is expected by the market to raise interest rates to 1.25% by the end of the year, an expectation that is deemed too ambitious by Bank of America and a consensus of analysts.

Any disappointment whereby the Bank declines to raise rates by a further 100 basis points could therefore create headwinds for Sterling.

Economists at Bank of America however forecast just two rate hikes in 2022 with 25 basis points coming in February and then by another 25 points coming in November.

This takes the base rate to 75bps by the end of the year, versus market expectations for 1.25%.

"Against this backdrop, we are bearish on the prospects for GBP this year," says Sharma.

Economists at Bank of America say Brexit will be a cause for concern for the UK economy, despite a free trade deal being agreed between the EU and UK at the end of 2019.

"Brexit matters and the UK is faced with a unique set of challenges compared to other G10 nations. The passing of the pandemic may ease some of the UK's supply chain issues, but not all. Developments towards the end of 2021 and GBP reaction suggest that Brexit will become a more significant narrative this year," says Sharma.

"GBP is in the process of yet another post-war reset in the aftermath of the Brexit Referendum," he adds.

The Pound to Euro exchange rate is forecast by the bank to end 2022 at 1.1236 (EUR/GBP at 0.89).

The Pound to Dollar exchange rate is forecast to end the year at 1.24.