Pound Sterling Can Still Fall Further Near-term say Analysts

• GBP/EUR down 2.0% last week
• GBP/USD down 1.90%
• Relief rally possible next week
• But momentum ultimately pitted against GBP near-term
• We look at some potential triggers to a broader recovery

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The British Pound suffered a significant loss in value against the Euro, Dollar and other major currencies last week and analysts say further losses are possible in the next week although a brief relief rally cannot be ruled out.

Pound exchange rates fell sharply in the wake of the Bank's decision to hike by 25 basis points but warn economic growth was likely to stall and inflation surge higher than they initially expected.

It was the Bank's latest set of forecasts, and the message contained within them that the market is anticipating too many hikes, that caused a recalibration lower in expectations, and the Pound.

"The Bank of England, in delivering its fourth consecutive rate hike, did so while warning of higher inflation and weaker growth! That triggered a negative market response in both global bond and equity markets. No-one wants stagflation," says Chris Iggo, CIO Core Investments, at AXA Investment Managers.

The Pound to Euro exchange rate fell 1.44% on Thursday alone and for the month of May it has lost 2.0%. The Pound to Dollar exchange rate is facing a more dire loss of 4.30% already for May.

JP Morgan's foreign exchange dealing desk writes to clients saying "the narrative is so powerful at the moment it is hard to see sterling recovering much ground".

From a tactical perspective the desk stays 'long' on Euro-Pound, i.e. they are actively positioned for further losses in the UK currency

0.8560 and 0.86 are seen as the next levels (1.1682 and 1.1630 in GBP/EUR). (Set your FX rate alert here).

Foreign exchange analysts at ABN AMRO meanwhile say they also anticipate further Sterling weakness against the Euro and Dollar.

"The updated projections and the ambiguous guidance on rates continue to stand in contrast to market expectations for further significant policy tightening, and the outcome of the meeting was clearly more dovish than the market expected," says Senior FX Strategist Georgette Boele.

ABN AMRO's economists expect two further rate hikes from the Bank in 2022, which represents a sizeable undershoot to what the market still expects.

These hikes are seen coming in June and August but thereafter they expect the Bank of England to shift in favour of the doves, as the risk of recession begins to weigh more heavily in policy deliberations.

"Our new view is still more dovish than what financial markets price in. Therefore, we still expect some more sterling weakness," says Boele.

ABN AMRO forecasts the Euro-Pound exchange rate to be at 0.85 by end-June, 0.85 by end-September and 0.86 by end-December.

This gives a Pound-Euro forecast of 1.1765 and 1.1630.

Their point forecasts for the Pound-Dollar exchange rate are 1.26 by end-June, 1.24 by end-September and 1.22 by year-end.

Those readers hoping for a recovery in the Pound should note that near-term momentum remains firmly pitted against the currency, although some near-term relief rallies might shape up next week.

But for now the consensus amongst currency analysts is that any strength is likely to be short-lived.

A more sustained recovery could however shape up once the market has fully washed away the perceived excess number of rate hikes it expects from the Bank.

After all this perceived excess has long been considered by analysts an axe hanging over the Pound's neck.

Incoming days shows other major economies are facing the same stagflationary outlook as the UK and when this realisation hits other currencies could come under pressure as central bank rate hike expectations elsewhere start to fade.

But this could take some time.

Pound Sterling Live reported Friday that Capital Economics, an independent economic research agency, tell their clients the Bank is too pessimistic.

They say the Bank's projections overestimate the potential economic downside and they will inevitably have to raise rates by at least as much as the market currently expects.

If they are right the Pound would be likely to recover lost ground as this realisation is more widely accepted.

However, this could take some time and a few months worth of official economic data would be required to shine light on this more optimistic outlook.