Goldman Sachs Forecasts Further Pound Sterling Underperformance against Euro

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The British Pound will endure a steady trend of decline in value agains the Euro over the coming 12 months shows research from Wall Street bank Goldman Sachs.

Updating clients in the wake of the Bank of England's June 16 policy update Goldman Sachs says the 25bp hike delivered was an "underwhelming response to acute inflation pressures".

"We have argued that the BoE’s more careful approach to taming inflation in order to cushion the growth impact is negative for the currency," says Zach Pandl, Co-head of FX strategy at Goldman Sachs in New York.

The Pound has fallen 2.20% against the Euro in 2022 already, with Pandl saying much of this decline is linked to investor perceptions towards the Bank of England's interest rate policy and the sense it is too timid in the face of rising inflation.

Nevertheless Pandl acknowledges the Bank has now signalled it is willing to potentially act more "forcefully" if inflation proves more persistent.

Given the Bank raised their peak inflation forecast to 11% year-on-year by October, from 10% previously, this inflationary pressure looks set to be realised.

Goldman Sachs join other economists in assessing the Bank has in effect signalled a 50 basis point hike is likely in August as it looks to play catch-up.

But Pandl says a 50bp hike is now well priced by the market and is therefore unlikely to materially shift Sterling's prospects.

"This is a popular view - sentiment on Sterling is quite negative, and it trades like it's well positioned," says Pandl.

He adds the Bank's Monetary Policy Committee (MPC) has a bias for caution and that some members have set a high bar when defining "more persistent" inflation.

As such, "the BoE's actions continue to stand out relative to its DM peers," says Pandl.

"We continue to look for further Sterling underperformance ahead, especially as the ECB debates a faster exit with a credit backstop in place," he adds.

Goldman Sachs forecasts the Pound to Euro exchange rate at 1.1363 in three months (EUR/GBP 0.88), 1.11 in six months (0.90) and 1.0869 (0.92) in twelve months.

However, Monday saw MPC member Catherine Mann argue that the Bank cannot afford to allow Sterling to continue loosing value.

She said there was a case to be made for a more "activist" approach to dealing with surging inflation, particularly because the Bank risks being left behind by peers such as the Federal Reserve and European Central Bank.

"While the MPC sets policy according to domestic macroeconomic conditions, as a so-called small open economy, the UK does not exist in a vacuum," said Mann.

Unless the Bank acts more forcefully it risks a decline in the value of the Pound which will push up the cost of UK exports and exacerbates the inflation problem.

"If the Fed tightens at the currently expected pace, and the ECB musters an increase soon the scenarios outlined above suggest additional depreciation pressure on Sterling that could add to inflation particularly in the near term," she added.