Pound Sterling's 'Purple Patch' Could be About to Fade says Bank of America

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Favourable April seasonality and data propelled the British Pound to its strongest valuation against a host of currencies since the start of the year, but momentum indicators look overbought and gains should fade says Bank of America.

The Pound is in something of a 'purple patch' at present and is the year's best-performing G10 currency owing to a run of better-than-expected data and favourable seasonal dynamics in April.

"We have witnessed a rare event where GBP TWI has delivered positive returns in the first three months of the year, only the second time in 25 years and with positive April seasonality also exerting its influence, we could see an unprecedented fourth," says Kamal Sharma, Senior G10 FX strategist at Bank of America in London.

The Pound has benefited largely thanks to a run of better-than-expected data outturns that continue to point to the economy being in a position to avoid recession.

Sentiment heading into 2023 was resolutely downbeat as major institutions such as the Bank of England, OBR and IMF pencilled in a multi-quarter recession extending from end-2022 to end-2023.

This informed broader sentiment towards the Pound and with gloomy expectations subsequently being proven wrong, the currency has rallied.

Bank of America's key call this year is that GBP should benefit from the removal of tail risk premium and news flow becoming "less bad".

"However, this may be as good as it gets," says Sharma. "The best of UK data surprises may be behind us and there is little encouragement that international investors are returning to UK asset markets - a necessary condition for medium-term optimism," he adds.

The Bank of America analyst says May and June have historically been weak months for the Pound which has fallen in every Q2 since 2016.

"This feeds into the narrative that strong April seasonality will eventually give way to fading the GBP rally," says Sharma.

From a technical perspective, Bank of America also finds the Pound's upside momentum is looking increasingly overbought with GBP/USD looking particularly overbought:

Above: GBP/USD 6mth annualized change. "GBP/USD momentum appears overbought" - BofA BofA Global Research. Data: BofA Global Research, Bloomberg and Bloomberg.

The Pound to Dollar exchange rate has appreciated to highs at 1.2550 amidst the broader retreat of the USD as the peak in the Federal Reserve's interest rate hiking cycle comes into sight.

Investors have also increasingly factored in rate cuts over the coming months as the recent run of economic data prompts economists to expect the U.S. economy to slide into recession in the second half of the year.

The pound to Euro exchange rate has meanwhile edged higher in every month of 2023 thus far but gains have been relatively small on a month-to-month basis.

This is because the Euro has also benefited from the lifting of gloomy predictions associated with fears of elevated natural gas prices and shortages.

The European Central Bank has meanwhile signalled it has more work to do by way of raising interest rates than its peers before it considers inflation to be firmly in check.