GBP/EUR July Outlook: Short-term Risks

• EURGBP a buy at HSBC
• As Bank of England hike expectations to cool
• Investec sees three quarters of recession ahead
• Predicts GBP fall to crisis levels against EUR

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The British Pound was the best-performing major currency of the first half of 2023, but the outperformance is unlikely to last according to analysts who say elevated Bank of England interest rate expectations now pose a headwind to the currency.

The Pound rose against the Euro, Dollar and all its G10 rivals through the first half of the year as UK economic data beat expectations and investors positioned for further interest rate hikes at the Bank of England owing to stubbornly high inflation data releases.

But this trade looks to have run its course and as July dawns analysts at HSBC say this leaves the Pound looking particularly vulnerable to a short-term pullback against the Euro as investors revisit expectations for a potential peak in interest rates at the Bank of England close to 6.0%.

"GBP has of course been supported by hawkish surprises on wages and inflation data. It is the best-performing currency in G10 so far this year. However, the upside has become increasingly constrained," says Paul Mackel, Global Head of FX Research at HSBC.

HSBC's FX tacticians look to capitalise on any 'dovish' disappointments in the UK data and cooling in rate hike expectations at the Bank of England by selling the Pound against the Euro.

Their research suggests EURGBP is more responsive to relative interest rate expectations between the UK and Eurozone than GBPUSD is to those between the U.S. and UK.

As such, HSBC recently opened a tactical trade to buy Euro-Pound and target a move to 0.8750. This equates to a sell in the Pound to Euro exchange rate with a target at approximately 1.1430.

Above: EURGBP has fallen as UK interest rate advantage grows, this would reverse if Bank of England hike expectations recede. Image courtesy of HSBC.

In a midyear review economists at Investec - the investment and commercial bank - say they now forecast a recession in the UK in the third quarter, fourth quarter and first quarter of 2024 which could send the Pound back towards crisis-era levels against the Euro.

The projections, if correct, point to UK economic data releases turning lower over the coming weeks as the impact of recent Bank of England interest rate hikes become more acute, posing disappointment for the Pound.

"We expect the MPC to succeed in breaking the price spiral – but for this to come at a cost," says Philip Shaw, an economist at Investec.

Investec also believes the Bank of England will be able to stop raising hikes before the market's expected 6.0% is achieved as a further 1.8m owner-occupier mortgages will be refinanced by the final quarter of 2024.

Tenants whose landlords have a mortgage will also feel the pinch from higher rates, via rents.

Investec GBP forecasts, image courtesy of Investec.

Refinancing of bank loans for businesses as fixed deals expire is also much more costly, as is financing via credit markets.

This would all point to a weaker Pound; "the macro backdrop looks more challenging than elsewhere in the near term, and to the extent UK inflation remains relatively high, this ought to hold back sterling," says Shaw.

Investec says the Pound will slip to 1.23 against USD and 1.10 against the Euro by year-end.

By the end of 2024, as inflation recedes, analysts see a slight rebound in the Pound, mainly against USD – to 1.28 but also against EUR, to 1.11.

Levels of 1.11 and below have been said by some analysts - and the charts - to represent 'crisis' levels for the Pound-Euro (financial crisis in 2008, Covid crisis in 2020 and Truss crisis in 2022).

Therefore, for those holding Pounds looking to buy Euros these forecasted levels would represent a particularly poor outcome given the recent highs just north of 1.17.