Pound Sterling at Multi-week Highs

• Pound to Dollar up 2.0% this week @ 1.2130
• Pound to Euro up 1.0% this week @ 1.1640
• Equity market rally supports GBP
• As do falling oil prices
• But, Goldman Sachs says rally set to reverse
• Wells Fargo fears a Fed backlash

Image © Bank of England

The British Pound extends a November rally amidst improving global investor sentiment and the easing of domestic fiscal concerns, although there is no shortage of foreign exchange analysts offering warnings the rally won't be sustained.

The Pound has primarily been aided by rallying global stock markets as investors return to stocks on the belief the Federal Reserve is entering a phase of smaller rate hikes, with a view to delivering a final hike in early 2023.

"GBP has had a very strong tie to risk appetite in recent years, and so a rebound in global sentiment will also help to boost GBP from somewhat undervalued levels," says Paul Mackel, Global Head of FX Research at HSBC.

Derek Halpenny, Head of Research for Global Markets EMEA at MUFG, says current market conditions are proving "ideal for the pound to advance... global risks conditions are key for the pound."

Above: GBP and NZD lead the pack this week.

The Pound reached a nadir in September as difficult global market conditions combined with anxieties related to the UK's fiscal outlook caused by the previous government of Liz Truss and her Chancellor Kwasi Kwarteng.

But October and November have seen global investors welcome the apparent restoration of fiscal responsibility by Prime Minister Rishi Sunak and Jeremy Hunt following the Autumn budget where it was announced savings of £55BN had been found via tax hikes and spending cuts.

This week's advance by the Pound is also attributed by analysts to PMI data for November, which were poor, but not as poor as expected. And for currencies, beating expectations is what counts.

A domestic sentiment boost came after the Supreme Court rejected a bid by the Scottish government to hold a unilateral referendum on independence, eliminating a potentially significant source of political uncertainty.

"If the court ruling had gone the other way, a sharp pound sell-off would have likely ensued," says George Vessey, an analyst at Western Union Business Solutions.

Further support for the Pound comes amidst strong demand for UK government bonds, which sends their yield lower and in turn drags down UK lending rates, a welcome source of support for the economy given the headwinds that are blowing.

"Yields fell globally while equity markets advanced. For a country with a large current account deficit and higher financing risks, these concerns were lessened," says MUFG's Halpenny.

Oil prices have also retreated significantly this week as a cap on Russian oil exports was reportedly likely to be set higher than expected, easing concerns Russia would pull supply for the market.

Further downside impetus to oil comes amidst news of new Chinese lockdowns which should ensure demand from the world's largest economy remains below long-term trends.

For the UK, lower oil prices are a significant deflationary event, which is ultimately supportive of the Pound.

"Lower crude oil prices and still low natural gas prices alleviate considerably the negative terms of trade shock on the euro, pound and Japanese yen. A close in Brent below the September low of USD 84.06 would be a technically bearish signal," says Halpenny.

Above: GBP/EUR at daily intervals showing a looming resistance zone which could hamper gains over coming weeks. Consider setting a free FX rate alert here to better time your payment requirements.

We have therefore witnessed a combination of supportive conditions for Sterling, and analysts at HSBC this week have said they have turned bullish on the Pound for the first time in years.

They see the Pound recovering through 2023 as the Dollar finally retreats and global sentiment improves.

But there might be bumps to navigate over the coming weeks.

"While the recent GBP performance has been consistent with our long-term constructive view, many pitfalls still lie ahead for the GBP on a nearer horizon," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The UK economy is forecast by the Bank of England and the Office for Budget Responsibility to slide into recession in the final quarter of 2022; they forecast the recession to last for a number of quarters.

Analysts at Goldman Sachs meanwhile warned ahead of the weekend that the Pound's current run of gains is unsustainable.

"We see little fundamental change in the UK outlook," says Michael Cahill, an analyst at Goldman Sachs in London.

"Last week’s budget left the energy price guarantee mostly unchanged, which is inflationary, but not targeted enough to quell BoE concerns about lower-income households, and financial stability concerns could re-emerge if gas prices rise again given its unbounded cost," he adds.

The analyst notes UK economic data continue to show that the labour market is even tighter than expected, and core inflation pressures are firmer, meaning the Bank of England will need to persist with growth-quashing interest rate hikes.

"And as long as the UK government continues to navigate these challenging shocks, political stability risks are unlikely to completely disappear," says Cahill.

Above: GBP/USD at daily intervals. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.

Goldman Sachs says the Pound's recent outperformance ultimately reflects an unwinding of "very negative positioning".

"But we think this has now mostly run its course, with our GBP Sentiment Index now back to neutral territory, so that should limit further outperformance," says Cahill.

The current rally in global markets could meanwhile prove unsustainable and Pound Sterling Live reported this week of research from PIMCO and BNP Paribas revealing that the current bear market in equities will last into 2023.

In fact, BNP Paribas says the capitulation moment, which typically marks the final leg of a bear market, has yet to occur.

If these predictions are right the Pound will surely press lower over the coming months.

A Dollar rebound and a pullback in global equity markets are indeed possible at some point in the coming weeks, according to a new analysis from Wells Fargo.

The U.S. bank says in a recent monthly research note the Federal Reserve will react to a recent easing in financial conditions, fearing that the falling bond yields will undermine their efforts to bring inflation under control.

This easing in financial conditions is further exacerbated by the recent decline in the Dollar: after all, a strengthening dollar is disinflationary for the U.S. as it means falling import costs.

"We are a little nervous that the 7% fall in the dollar against the currencies of its main trading partners and the 45bp drop in the 10Y Treasury yield is leading to a significant loosening of financial conditions – the exact opposite of what the Fed wants to see as it battles inflation," says Nick Bennenbroek, International Economist at Wells Fargo.

"Consequently, we wouldn't be surprised to see the Fed language become even more aggressive over the coming week, talking about higher terminal interest rates – with some of the more hawkish members perhaps even opening the door to a potential fifth consecutive 75bp hike in December to ensure the market gets the message," he adds.

This could rejuvenate a Dollar bid and equity market selloff, leading to a broader turnaround in the Pound.