British Pound: BoE Rate Hike will be No Saviour, Sterling to Struggle v Euro and Dollar

• Pound to Euro exchange rate today: 1 GBP = 1.1393 EUR, day's high: 1.1411, low: 1.1374
• Pound to Dollar exchange rate today: 1 GBP = 1.2938 USD, day's high: 1.2960, low: 1.2917

Pound Sterling might struggle to find further strength against the Euro and Dollar from current levels, even if the Bank of England goes ahead and raises interest rates argue researchers.

For Sterling-watchers, markets have recently shifted emphasis on what matters for the currency with eyes turning from domestic politics and Brexit to the Bank of England.

Money markets presently have odds of an interest rate at the Bank of England being at 50/50 by the time the year is out.

We saw the Pound enjoy its best week in months at the end of June as two of the Bank’s ‘big guns’ said a rate rise might be necessary owing to the UK’s elevated inflation rates.

Both Governor Mark Carney and Chief Economist Andy Haldane dropped hints that such a move was imminent within hours of each other.

Markets have repriced from suggesting a negligible chances of an interest rate hike a month ago, to even odds by end-2017 and nearly full-odds by end-2018, with GBP strengthening commensurately.

Can this Gift Keep Giving?

The question now, at the start of July, is whether this theme of ‘higher interest rate expectations = a higher exchange rate’ can continue delivering a stronger Sterling.

“We note however that Carney’s concession of the possibility of hikes was couched in conditionality, we still think the bar for a rate hike is very high given expectations of subdued growth over 2H17 and ongoing uncertainty around the Brexit transition process,” says Daniel P Hui at JP Morgan.

The question of Brexit makes, “the repricing phenomenon in the UK inherently different than that seen most elsewhere, which is motivated by downside risk reduction or outright reflationary conditions,” adds Hui.

This calls into question the general rule of thumb that rising interest rates are positive for the British Pound.

“With potential BoE hikes only motivated by upside inflation risk, in spite of a poor growth outlook, higher rates are more ambiguous for the currency, given the greater risk of a policy mistake that undermines the economy,” adds the JP Morgan analyst.

The risk for Sterling is that inflation rises start slowing over coming weeks, particularly as global fuel prices have turned around. Furthermore, the one-off impact on prices of a fall in Sterling appear to be easing as suggested by the latest survey data on hand.

June’s manufacturing PMI shows price pressures on UK manufacturers has eased significantly, and the pass-through of this easing will soon be felt on the high-street.

This might convince the Bank to keep interest rates unchanged for longer.

And there is the suggestion that even if the Bank were to go ahead and raise interest rates, the move might be damaging for the economy and, by extension, the Pound.

Could we already be seeing the view that a potential interest rate rise in 2017 is not necessarily positive for Sterling as GBP/USD fails to breach above the 1.30 level once more?

Analysts at JP Morgan are “ambiguous” as to what a rate rise means for the UK economy and the currency. They reckon the Pound should struggle going forward, “we remain wary of GBP strength and biased to trade Sterling from the short side,” says .

Others believe an interest rate rise would in fact be an outright negative.

“Those who advocate a rate hike believe the combination of high inflation and low unemployment – two cyclical considerations – warrants action,” says HSBC Strategist David Bloom.

Even in such a cyclical world, Bloom argues the case for rate hikes in the UK are not clear cut – a lot of economic activity data (e.g. wage growth, retail sales) have disappointed in recent months.

For HSBC, the dominant issues for the UK are structural and political in nature.

“In the structural and political world that GBP inhabits, we believe rate hikes could be damaging,” says the analyst.

Where is the Pound Going then?

Based on the above it comes as no surprise that HSBC holds a decidedly more negative view on Sterling’s outlook given their conviction on the negativity towards the economy and the potential impact of any interest rate rise.

Latest in-house forecasts at the British bank see GBP/USD going down to 1.20 by year-end, and GBP/EUR going down to parity.

JP Morgan are more generous on Sterling and see stability characterising the market over coming months as they eye a GBP/USD exchange rate of 1.20 being struck at year-end.

The GBP/EUR exchange rate is at 1.1364.