Pound Sterling Poised for Further Declines Amidst Unyielding Investor Negativity Towards the UK

It is the UK economy and its currency that is bearing the brunt of the market's pessimism and until investors change their view Sterling will be destined to test ever lower levels.

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The British Pound's relentless slide against the Dollar, Euro and other major currencies continues amidst overwhelming investor negativity towards the UK economy.

The Eurozone, U.S. and UK economies are all facing soaring inflation rates and a sharp economic slowdown, while their respective central banks are promising to raise interest rates further.

But it is the UK economy and its currency that is bearing the brunt of the market's pessimism and until investors change their view Sterling will be destined to test ever lower levels against both the Dollar and Euro.

With no major economic data releases likely for some time and the Bank of England's next policy decision only falling due in August it appears the trend of selling Sterling against everything is here to stay.

The Pound to Euro exchange rate is trending lower and has fallen for three weeks in succession and is down a further half percent this week at 1.1550.

Above: GBP/EUR at weekly intervals showing performance since the start of 2021.

The Pound to Dollar exchange rate is meanwhile down a further 1.30% this week at 1.21 and further losses look likely.

"A soft landing is no longer possible in the UK," says Daniel Tenengauzer, Head of Markets Strategy at The Bank of New York Mellon.

Soft landing refers to the comedown in UK economic activity resulting from surging inflation and higher central bank interest rates and typically describes a recessionary outcome.

Tenengauzer points out to clients in a recent research note the Bank of England already expects unprecedented declines in real incomes and its fear of household cashflow falling off a cliff has prevented stronger moves on rates.

He adds the government has belatedly provided some energy subsidies for households, but recession is already the base case for the Bank of England.

But, "we would stress, however, that GBP valuations are at a level which likely precludes further broad-based declines," says Tenengauzer.

When the market is so heavily invested in a one-way trade against a currency it can run out of participants to take the other side of that trade, which actually slows the move down.

This is hardly a fundamental vote of confidence for the Pound and suggests any relief gains will inevitably be sold into.

Valentin Marinov, Head of FX Strategy at Crédit Agricole agrees and says the Pound "can only really rely on the fact that it is undervalued and oversold for some respite."

Above: GBP/USD at weekly intervals showing performance since the start of 2021.

Jane Foley, Senior FX Strategist at Rabobank, says the Bank of England might have been "quicker out of the blocks on policy tightening than many other G10 central banks this cycle. However, the five interest rate hikes announced by the BoE already have not prevented the pound from being one of the poorest performing G10 currencies in the year to date."

Indeed, Pound exchange rates raced ahead at the start of 2022 as investors saw the Bank of England leading the charge in normalising interest rates, which is typically considered supportive of a currency.

But the UK currency's fortunes suffered a reversal as inflation surged and energy prices rocketed following Russia's invasion of Ukraine.

Another energy price cap rise by industry regulator Ofgem in October also means the UK's inflation peak will be behind those of other advanced nations.

Foley says although the Bank of England will likely raise interest rates in response to expectations for further inflation it may not provide the Pound with much lasting support "given investors overriding concerns about UK investment and growth".

Rabobank forecasts EUR/GBP ending the year around 0.88, which gives a GBP/EUR target of 1.1363. (Set your FX rate alert here).

"More aggressive rate rises now could accentuate downside growth risks in the medium-term and this is likely to further worry GBP investors," says Foley.

Stephen Gallo, European FX Strategist at BMO Capital Markets, says Sterling will lag the Euro and Dollar owing to the fact the Bank of England has to wait until August before it can hike next, while the ECB and the Fed both have July policy announcements.

He adds a renewed focus on second Scottish independence referendum and the country's poor international trade dynamics are two further reasons to steer clear of the Pound.

"We continue to favour GBPUSD lower towards the 1.20 level," says Gallo.