GBP/USD Forecast: Nomura says a Fall to 0.97 is Now a Sure-fire Bet

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Foreign exchange strategists at Nomura are as sure as they possibly can be that the Pound to Dollar exchange rate is on course for a substantial decline that takes it below parity.

In a client update released on October 12, the investment bank says its long-running recommendation to sell the Pound against the Dollar remains intact, and if anything recent events raise their conviction.

"Given the state of rates volatility, FX is probably the easier and less volatile way for investors to express the bearish UK/global growth view right now," says Jordan Rochester, a strategist at Nomura.

UK bond markets have experienced significant volatility since late September when the UK government announced a package of unfunded tax cuts.

Investors fear the tax cuts, when combined with a substantial spending package to help households with their energy bills, will put the UK's finances on an unstable footing.

Gilt yields have surged as investors demand greater compensation for holding UK debt, in turn raising the cost of finance through the economy.

Expectations amongst economists for a lengthy UK recession are rife, with some warning risks to growth being skewed firmly to the downside.

"The picture for the UK is likely to remain rather bleak, with consumer confidence at all-time lows pointing to a potentially severe recession risk for the UK," says Rochester.

Near-term, the Pound could rally against the Dollar as the 'short' GBP/USD trade is heavily crowded, opening the door to a potential 'squeeze' higher.

This could be triggered by a softer set of inflation data out of the U.S. on Thursday.

The UK government could also reverse its tax cutting agenda and the Bank of England could perhaps extends its long-end gilt support for a few more weeks.

"GBP doesn't want to go down. It should be going down, but it's not. Starting to look like the tiniest change in narrative there would be explosive. Kwarteng fired would be the obvious one," says Brent Donnelly, CEO of Spectra Markets.

"Though sometimes there is just an endogenous stabilization, sans news... This feels like one of those," he adds.

But Nomura says the Pound's fate is sealed.

"The main reason why GBP should continue to fall is declining global growth expectations, risk sentiment on the back foot and the UK's significant current account deficit over winter with the risks of energy blackouts," says Nomura.

"We expect GBP to reach parity by end-November, 0.975 by year-end and raise our conviction to 5/5," says Rochester.

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Above: "Short GBP/USD (since 24 Feb; entry: 1.3460; target: parity by end-November, 0.9750 by end-2022, and 0.9500 in Q1 2023; conviction at 5/5)".

He adds that the Pound's decline is unlikely to reverse until growth rebounds.

Nomura has been 'short' Sterling since February, entering a 'sell' recommendation when Pound-Dollar was at 1.3460.

Economists elsewhere are meanwhile increasingly of the view that the recent turn of events that has seen the cost of borrowing spiral higher will deepen the recession in the UK.

Lending costs have risen sharply as investors demand greater compensation for buying UK debt (bonds, known as gilts), pushing up the cost of mortgages and other forms of credit.

"The cost of living crisis will be exacerbated by a cost of borrowing crisis," says Paul Dales, UK Economist at Capital Economics.

Ross Walker, Head of Global Economics and Chief UK Economist at NatWest Markets, says the borrowing crisis will manifest most acutely in mortgages and this will translate into a recession that hits middle-income households the hardest.

"What began as an energy-centred shock which would hit the bottom-third of households by income hardest is evolving into a more conventional monetary policy shock which will hit middle-income households hardest," says Walker.

NatWest's central case for the UK economy in 2023 is for recession, with UK GDP contracting 0.8% year-on-year, as Bank of England interest rate hikes exert a sharp and persistent squeeze on household disposable incomes and demand.

The UK lender forecasts negative quarterly GDP outturns from the third quarter of 2022, persisting throughout 2023.