"Deep Cuts" to Pound Sterling Forecasts at JP Morgan

• GBP the poster child of stagflation
• GBP/USD to fall well below 1.20
• EUR/USD to parity
• But EUR/GBP forecasts raised

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The UK is the "poster child for stagflation" says investment bank JP Morgan as it announces "pretty deep cuts" to their British Pound forecasts.

Updating their Sterling forecast profile in a regular monthly currency briefing JP Morgan also says the Dollar's trend of appreciation is not yet complete while they think the Euro will also come under further pressure.

Analysts say the Pound is trapped in a stagflationary vortex that will see inflation rise sharply in the near-term and economic growth fall to "a borderline recession".

"To describe this combination of double-digit inflation and zero growth as toxic for the exchange rate would be an under-statement," says Paul Meggyesi, Head of Global FX Strategy at JP Morgan in London.

"We are making pretty deep cuts to our GBP forecasts once again this month," he adds.

Above: Cumulative change in JPM GDP forecasts. "UK GDP forecasts have been slashed by even more than the Euro area in the last few years, and massively lag the US" - JP Morgan. Image Source: J.P. Morgan.

The forecast changes were formulated ahead of the recent rebound in the value of the Pound against the Dollar, which has seen the Pound to Dollar exchange rate recover to 1.2573 from lows at 1.2155 reached in mid-May.

At the time some analysts were warning that a break below 1.20 was looking increasingly inevitable.

The Pound to Euro exchange rate has also recovered from mid-month lows to quote at 1.1778 at the time of writing. (Set up a free FX rate alert here).

The losses that characterised the first half of May were largely the result of the market's negative reaction to the Bank of England's policy update of May 05, when the central bank spelled out how poorly they now expected the economy to fare over coming months and years.

But the rally by the Euro and Pound Sterling against the Dollar witnessed over recent days will be viewed as a countertrend relief-style bounce within the context of JP Morgan's predictions.

Therefore if Meggyesi and his team is correct the current bounce will be relatively short lived.

Above: Market pricing for the terminal rate this cycle. "Concerns that the economy won’t be able to withstand front-loaded rate hikes are keeping a cap on pricing for the BoE terminal rate, in contrast to other DM central banks" - JP Morgan. Image source: JP Morgan.

JP Morgan says its GBP forecast cuts also reflect a heightened possibility that UK trade relations with the EU are subject to retaliatory measures should the UK make unilateral changes to the
Northern Ireland Protocol.

This would add to what they describe as a "quite a concerning deterioration in the UK’s
trade imbalances this year."

Slashed Pound Sterling Forecasts

JP Morgan lowers its one-year GBP/USD target from 1.31 to 1.16.

A trough is predicted in the third quarter when the pair falls to 1.14.

EUR/GBP forecasts are meanwhile raised to reflect a "negative relative cyclical outlook".

The one-year forecast is lifted to 0.88 from 0.84, the third quarter forecast is also set at 0.88.

"The UK’s status as the posterchild for stagflation is imbedded in the upward revision to the EUR/GBP forecast," says Meggyesi.

EUR/GBP at 0.88 gives a GBP/EUR exchange rate of 1.1363.

Stay 'Long' the Dollar

Analysts meanwhile maintain a view the Dollar's multi-month trend of appreciation is not yet done.

"Macro conditions in the past month have become even more conducive to this bullish USD view," says JP Morgan currency strategist Meera Chandan.

"That US growth downgrades have also begun does not bode well for risk markets and could also indicate that demand is broadly softening as well. This represents a shift from US exceptionalism to an outright global slowdown which would still be dollar supportive," says Chandan.

Valuations are not yet a headwind with modelling showing the U.S. currency to be fairly valued relative to the growth downgrades we have in hand already; "it does not yet represent an excess premium for tail risks".

EUR/USD to Parity

Combined with an ongoing bullish U.S. Dollar case, JP Morgan see significant idiosyncratic risks facing the Euro.

"The market is finally accepting that the Ukrainian war is a disproportionate shock to the Euro area economy and threat to the currency that we have argued it will be since the onset of the war," says Meggyesi.

The analyst says "the market is abandoning its belief that accelerated ECB tightening predicated on the surge in inflation despite risks to growth would boost EUR".

EUR/USD is forecast to fall to 1.00 by September 2022.

Above: EUR-USD 5Y inflation swaps and 5Y real yields. "ECB hawkishness is predicated on inflation despite the risks to growth. The prospect of stagflation is FX negative whatever the CB does, as illustrated by the slide in EUR's real rate support" - JP Morgan. Image source: JP Morgan.

However, we note the call came ahead of a number of interjections by European Central Bank Governing Council members, all who called for an imminent start to rate hikes.

A July rate hike of 25 basis points was meanwhile cast in iron by ECB President Christine Lagarde on May 23 who said in an extraordinary blog post that the period of low Eurozone inflation had come to an end.

She signalled another 25 basis point hike was likely in July.

Euro exchange rates rose sharply on the communications.