Pound Sterling Forecast to Recover against Euro and Dollar at Investec

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New research from Investec finds the "gloom in macro expectations for the UK may be overdone" and they forsee a recovery in the British Pound over coming months as a result.

The global lender and financial services provider says although they have lowered their UK economic growth forecasts for 2022 and 2023 they do not believe a recession in the UK is inevitable.

Instead, strong wage dynamics and the spending of savings amassed during the Covid pandemic will provide a cushion for the economy during the 'cost of living crisis'.

"Some of the gloom in macro expectations for the UK may be overdone," says Philip Shaw, Chief Economist at Investec in London. "Momentum in wages and employment is strong, as are buffers from high savings."

Concerns for the UK economic outlook have grown in response to surging domestic inflation, largely a result of higher energy prices.

Above: "UK consumer price inflation is now the highest in the G7" - Investec.

Consumer confidence has meanwhile fallen to record lows by GfK's measures and preliminary PMI surveys of the economy for May showed a drastic slowdown in activity and business expectations.

In tandem, the Pound to Euro exchange rate has fallen back to record a 1.0% loss for 2022 and the Pound to Dollar exchange rate has registered a 6.5% loss for the year.

"Real incomes stand to fall; and rising costs squeeze firms’ margins. That is likely to weigh on growth," says Shaw in a regular monthly economic forecast update.

Investec economists lower their 2022 GDP forecast by 0.6 percentage points to 3.4% and their 2023 forecast by 0.5 percentage points to 1.7%.

They expect inflation to peak at 10.3% in October and to "retreat only slowly from here, falling below 2% only in Q4 2023".

Yet, the labour market is expected to remain robust as the ONS reported vacancies now outstrip the number of people seeking work for the first time ever.

This is anticipated by the majority of economists we follow to keep wage pressures in the UK elevated, which in turn poses a dilemma for the Bank of England's Monetary Policy Committee: do they continue to raise interest rates in light of rising inflation and strong wages, or do they soon pause in anticipation of falling growth?

The answer could determine how the Pound trades over coming weeks and months.

"The extreme tightness of the labour market argues for further swift rate hikes for now," says Shaw.

"Because the cost squeeze for firms is not solely due to the vagaries of world prices, and specifically because the extreme tightness of the labour market portends further wage rises, we view this as leaving little choice but to press on with additional frontloaded policy tightening for the Bank of England, to cool demand," he adds.

Investec now anticipate Bank Rate to be at 1.75% by year end, up from 1.0% currently.

Above: "Sterling looks poised to strengthen most against a retreating US dollar" - Investec.

As a result, "we still look for GBP to appreciate, especially against USD," says Shaw. "from the currency perspective, we see the most likely scenario to be a recovery in GBP following its weakening from the start of the year."

Investec forecast the GBP/USD exchange rate to trade at levels of 1.30 at the end of 2022 and 1.37 at the end of 2023. (Set your FX rate alert here).

"Against EUR, we foresee more limited gains. Some of the gloom in macro expectations for the UK may be overdone, but as policy rates start to rise in the Euro area, this may support demand for EUR," says Shaw.

Investec forecast the EUR/GBP exchange rate at 0.85 at the end of 2022 and 0.84 at the end of 2023.

This translates into a GBP/EUR forecast of approximately 1.1764 and 1.19.