Pound Sterling December Forecast versus the Euro and Dollar

• GBP ends November on firm footing
• But markets displaying signs of indecision
• Analysts look for a turn lower in GBP/USD and GBP/EUR near-term
• HSBC says USD trend to turn in 2023

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The British Pound ends November on a solid footing against the Dollar and Euro but there is a distinct uncertainty amongst analysts as to how the coming month of December will play out.

The Pound to Euro exchange rate looks set to end November slightly softer against the Euro (-0.18% as we move through the final session), but it is nevertheless 2.20% higher than at its lowest point, which was reached in the wake of the poorly received Bank of England interest rate decision and Monetary Policy Report.

The Pound to Dollar exchange rate is looking to record one of its strongest-ever monthly gains having ended November a solid 4.55% higher meaning it has advanced 15.5% since its September low.

Foreign exchange price action has however been difficult to divine over recent days with multiple drivers in play and analysts appearing increasingly uncertain as to what the next few weeks will bring.

This makes for difficult market conditions for those readers with imminent international payment decisions and emphasises the need to be nimble and reactive to market movements.

Daragh Maher, Head of Research for the Americas at HSBC, describes a "recently fickle world of FX," in a regular daily note to clients.

"This choppiness in the currency is symptomatic of a trend that is ending but where the market is battling between deniers and accepters," he says.

The big trends of late have been Dollar outperformance and Pound Sterling underperformance.

"The USD has performed very well over the last 18 months, but a number of the forces that propelled it towards its highest valuation in decades are seen losing ground," says Paul Mackel, Global Head of FX Research at HSBC.

"After a volatile few months following a year of underperformance, the tide may be turning for the better for GBP. Structural weaknesses will not completely turn around overnight, but the risks are much better priced at these levels of FX and rates," says Mackel.

If HSBC is right, and the USD and GBP are to see their fortunes turn, then further randomness in FX markets is likely over the coming days and weeks before 2023 gives way to the bigger directional trends. (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 here.)

"Headlines may prove unusually provocative, but with little lasting traction," says Maher of the near-term prospects for currency markets.

Above: GBP/EUR at daily intervals showing the stronog layer of resistance that is capping gains. Consider setting a free FX rate alert here to better time your payment requirements.

News out of China will be particularly important over the coming days and weeks with 'risk on' currencies rallying on expectations for a gradual ending of the country's zero-Covid policy.

This was however challenged on Monday in light of weekend protests against any returning of restrictions, but by Tuesday the mood had swung again as authorities confirmed they were indeed shifting policy.

The Pound tends to outperform in times of positive sentiment, therefore headlines of a Chinese reopening were supportive, particularly against the Dollar.

Yet, currencies such as the Australian and New Zealand Dollars will prove the outperformers if this theme extends over the coming days. The Euro could also benefit as the Eurozone's traditional current account surplus depends heavily on Chinese demand.

Friday's release of U.S. labour market data will be another near-term event of consequence for markets as investors try to gauge whether the U.S. economy really is slowing down.

The Dollar would likely come under fresh pressure if the data is softer than expected, but given the extent of the currency's recent weakness risks look pivoted towards a strong near-term comeback if the data is stronger than expected.

"We lack enthusiasm to chase the move lower," says Mark McCormick, Global Head of FX Strategy at TD Securities, of the Dollar's recent bout of weakness. "We think we're at nice levels to fade some of the recent optimism priced into markets, highlighting the scope for some USD consolidation."

Above: GBP/USD at daily intervals.

"Markets are keeping an eye on developments in China with some concern as they prepare for two key risk events – Jerome Powell's speech tomorrow and payrolls on Friday – which look more likely to push rate expectations higher rather than endorsing dovish speculation. When adding the very inverted US yield curve, a dollar recovery may be on the cards this week," says Francesco Pesole, FX Strategist at ING Bank.

The Pound would be an all-around under-performer in the event of a negative equity market reaction to news out of China or the release of strong U.S. data, courtesy of the UK currency's sensitivity to global investor sentiment.

"We see room for further depreciation into the end of the year as the greenback finds more support and the pound suffers from a bleak UK economic outlook," says Pesole.

Losses would also be expected against the Euro, according to some; "we still like EUR relative to GBP," says McCormick.

George Vessey, foreign exchange analyst at Western Union Business Solutions, says the Pound could be set to pare recent gains against the Euro and Dollar.

"Near-term risks still appear skewed to the downside for sterling and a pullback towards $1.16 versus the US dollar is still possible before year-end or early 2023. GBP/EUR slipped over a cent yesterday with the daily and weekly charts exhibiting a bearish double-top pattern forming. A fall below €1.1350 is needed to confirm this though," says Vessey in a recent briefing.

The key domestic event for the Pound will be December 15's Bank of England interest rate decision, where another 'dovish' surprise would set the currency on a weaker footing for the festive period.

The market is split on whether the next hike will be another 75 basis point hike or a 50bp move, suggesting a level of uncertainty that could provide FX markets with some excitement mid-month when the next decision falls.

The Bank of England has lifted Bank Rate to 3.0% as it tries to combat rising inflation. Catherine Mann, an external member of the Bank of England's Monetary Policy Committee, said on Tuesday UK inflation could risk getting stock closer to 4.0% unless the Bank continues to hike rates.

She has consistently said it would be prudent to deliver a series of large interest rate hikes early on to get a grip on inflation expectations, thereby ensuring the overall amount of hiking is limited.

But, the MPC has tended to err on the side of caution, disappointing against market expectations for the size of the hikes required, triggering weakness in the Pound as a result.

"BoE risks still revolve around their dovish tendencies. Too much of a focus on growth risks would raise market concerns that inflation might not be adequately dealt with. Inflation will remain in double figures through Q1," says Peter McCallum, Senior Macro Strategist at Mizuho International.

If the Bank plays true to recent form then another dip in the Pound might be possible come mid-month.