Pound Sterling a Buy vs. Euro Says BCA, Warns Bank of England Rate Cut Bets Too Optimistic

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The British Pound is an attractive 'long' candidate against the Euro and other G10 currencies as the Bank of England won't cut interest rates by as much as markets expect.

This is according to BCA Research, an independent economic research and strategy provider; "market expectations of BoE rate cuts in 2024 look too optimistic. Expect fewer cuts this year."

The call comes just days ahead of the Bank of England's May 09 interest rate decision, where there are risks that it signals a June interest rate cut. The market is currently priced for about two 25 basis point interest rate cuts from the Bank of England in 2024, with the first happening in August.

We saw the Pound come under pressure in April when bets for more interest rate cuts were increased. The Pound to Euro exchange rate dropped out of its 2024 range, falling to a multi-week low at 1.1570. The Pound is at risk of declining once more if the Bank boosts rate cut expectations once more.

"The pound is susceptible to BOE risks into the May 9 meeting. The MPC is gradually pivoting more dovish," says a weekly FX note from Barclays.

But, recent comments from Bank of England Governor Huw Pill pushed back against growing rate cut bets and supported a recovery in Pound exchange rates, confirming that expectations for fewer rate cuts, as per BCA's expectations, can support the Pound.

"Look for opportunities to go long the British pound versus the euro, Canadian dollar, and Swedish krona on pullbacks in those crosses," says Chester Ntonifor, Foreign Exchange Strategist at BCA.

In a new special report on the UK economy, BCA says the Bank of England needs to do more to lower inflation owing to elevated UK wage pressures. It says the Bank will need to generate a 'hard landing' for the economy in order to raise unemployment and bring wages down.

Above: "The Path To Lower Service Inflation" - BCA Research.

"UK inflation cannot sustainably return to the Bank of England 2% target without a sharp reduction in services inflation, which remains far too elevated at 6.0%," says Robert Robis, Chief Fixed Income Strategist at BCA. "Our models show that UK services inflation is primarily a function of wage growth, which itself is driven by inflation expectations and the demand/supply balance in the labour market."

Currently the Bank of England expects growth to remain positive and inflation to fall, in what is considered a soft landing for the economy. A hard landing would require a recession to create the economic slack to starve inflationary trends.

Interest rates will have to stay longer than markets currently expect, which is, all else equal, potentially supportive of Sterling.

"The UK labour market remains far too tight to expect wage growth to slow to levels consistent with the BoE's inflation target – around 3-3.5% versus the current 6%," says Robis. "We estimate that it will take a meaningful rise in UK unemployment to between 5-6% from the current 4.2% - in other words, a significant recession – to generate that target-consistent wage outcome."

Above: "The UK Needs A Much Weaker Labor Market To Cool Off Inflation" - BCA Research.

A number of key Bank of England members spoke in April and one, Dave Ramsden, indicated he was now more confident inflation is on course to fall to the 2.0% target sustainably, which some economists and analysts saw as an admission that interest rate cuts could begin as soon as June.

The Pound fell in response.

But, BCA says the higher-for-longer interest rate regime it expects can underpin the Pound, particularly against currencies belonging to central banks that will likely cut by more.

"The BoE will have to keep monetary policy tighter for longer than markets expect. This is especially true with the UK economy now rebounding from the "technical" recession in 2023," says Robis.

The higher for longer regime can support the Pound against the Euro, Canadian Dollar and Swedish Krona, according to BCA. However, strategists anticipate the Dollar will remain king, pressuring Pound-Dollar closer to an expected floor near 1.22.

Expectations for higher-for-longer interest rates through 2024 can support the Pound. However, BCA thinks the Bank will cut interest rates in earnest in 2025 in response to recession, which will be fundamentally unsupportive of the Pound.