Pound Dollar and Pound Euro Recovery Seen, Data Shows UK Economy 'Vastly Outperforms' Rivals

Weekend comments by Bank of England Governor Carney on the timing of UK interest rate rises has caught the attention of markets who have reacted by buying the currency. See comment below.

Nevertheless, the mid-August trading period proved to be a dismal one for the UK's pound sterling with the currency being hit hard against the majority of its rivals.

A look at the currency markets at the time of this article's last update shows:

• The pound to euro exchange rate (GBP/EUR) is 0.06 pct lower on a day-to-day basis at 1.2511.
• The pound to dollar exchange rate (GBP/USD) is 0.16 pct lower at 1.6701.

Please Note: All quotes here are taken from the wholesale markets. Your bank will affix a spread at their own discretion. However, an independent FX provider will guarantee to undercut your bank's offer, thereby delivering up to 5% more FX.

Boost for GBP

On Sunday Bank of England Governor Mark Carney, in an interview with Sunday Times, said that the BoE could hike rates before wages start to increase.

“‘We have to have the confidence that prospective real wages are going to be growing sustainably before raising borrowing costs but we don’t have to wait for the fact of that turn to raise them," Carney told the paper.

“GBP strengthened on the comments against all G10 currencies overnight and EUR/GBP initially dipped below 0.80 earlier this morning,” notes Danske Bank analyst Morten Helt.

In the previous week the ONS confirmed the UK is in fact the fastest growing major economy after annual growth was notched up to 3.2 pct, its best performance in more than six years.

This comes a day after it was shown the Eurozone registered 0% growth in the last quarter.

Nevertheless, currency markets were only interested in continuing their GBP sell-off marking one of the worst weekly performances for sterling in 2014. .

Pound Dollar + Pound Euro Dips Will Be Shallow

The UK economy continues to outperform its rivals, this is hard to dispute. It is however also wrong to second-guess the currency markets and the current sell-off still shows signs of extending in the near-term.

Nevertheless, the longer-term fundamentals point to a strong UK economy that should keep sterling underpinned. We would therefore allow for the current sell-off to run out of steam, which it is possibly doing at present.

Boris Schlossberg at BK Asset Management says:

"The year over year figures were a tad bit better with growth coming in at 3.2% versus 3.1% initially eyed. This was the highest GDP reading since Q4 of 2007 and clearly showed that UK economy continues to vastly outperform the rest of the G7 universe. The growth was well distributed with services and manufacturing growing about 3.3% on year on year basis."

BUT - GBP/USD Has Scope to Fall Further Warn Lloyds

Despite the strong fundamentals backing the GBP we must look forward and take into account the performance of other economies. While the UK's economic performance is largely priced into the markets, the same cannot be said for the US.

The US economy is showing encouraging signs of growth, and were this to pick up further then the GBP/USD could be left exposed.

Indeed, the latest monthly currency forecast from Lloyds Bank suggests the GBP is overvalued against the dollar.

Commenting on the currency's outlook, Lloyds say:

"A combination of geopolitics, mixed data and thin summer trading conditions has pulled sterling lower. Since hitting a peak of just under $1.72 in mid July, GBP/USD has fallen to below 1.68.

"The pound has also ended the month slightly weaker against the euro, at €1.2550 (having reached a 2-yr high of 1.27 in late July). It is difficult to disentangle how much of sterling’s drop has been due to temporary factors and how much reflects a genuine shift in sentiment.

"We stick with our long-standing view that GBP/USD remains overvalued and has scope to fall further over the coming months if, as we expect, forthcoming data continue to highlight the improvement in the US economy and BoE communications provide, at worst, a balanced assessment of the UK monetary policy outlook.

"The uncertainty surrounding the Scottish Referendum poses an additional downside risk. However, the relatively weaker growth and policy dynamics of the euro area suggest GBP/EUR weakness is likely to be short-lived. We look for GBP/USD and GBP/EUR to end 2014 at 1.68 and 1.27, respectively."