Pound Sterling and Euro Bulldozed by Surge in Demand for Dollars as 2023 Gets Underway

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There was a strong bid for the Dollar at the start of the first London session of 2023, with both the Euro and British Pound losing ground by an equal measure.

The Dollar was 0.80% higher against both European currencies as doors opened for London markets following a relatively uneventful Christmas trading period.

The sizeable rally serves as a timely reminder that it is too soon to write off 2022's best-performing currency.

"FX also comes alive this morning with the dollar fighting back from the lows," says analyst Kenneth Broux at Société Générale. "The mean-reversion in yields and the move in the dollar occurred on a day devoid of new macro news... this can only suggest that the run-up in yields and dollar weakness last week was exaggerated and linked to year-end and thin liquidity."

From a seasonal perspective, January is traditionally a strong month for the Dollar, and weakness in GBP/USD over the coming weeks is possible.

"The dollar has surged against most of the major currencies," says Marc Chandler, Chief Market Strategist at Bannockburn Global Forex. "The strong greenback gains seem like a bit of unwinding some of the weakness seen in thin holiday markets, and what we suspect, is an overdue technical bounce."The UK currency endured a soft end to 2022 as demand ebbed amidst a broadly unsupportive global market backdrop - one characterised by weak equity markets - and an enduring consensus that the UK economy will struggle in 2023.

Much will hinge on how global investors behave and whether the equity bear market can extend.

We have covered the views of various economists that state the bear market is by no means over and it will only be towards mid-year when a more enduring turnaround can commence.

If this is the case, the Pound might remain under pressure over the coming weeks and the Dollar and Euro would be better supported.

The Pound to Euro exchange rate (GBP/EUR) fell 2.50% in December as the Euro rebounded amidst falling domestic gas prices; the Pound to Dollar exchange rate (GBP/USD) registered a gain of just 0.33% as it respects a relatively flat profile on the daily charts.

GBP/USD is now trading below 1.20 at 1.1950, taking dollar payment rates to around 1.1711 at typical high-street banks, 1.1842 at competitive holiday money and cash providers and 1.1914 at competitive international payment providers.

GBP/EUR is trading at 1.1323, bank rates are near 1.1097, cash and holiday rates are near 1.1221 and international payment rates are quoted towards 1.1289.

Above: GBP/USD and EUR/USD showing the strong bid as London markets return from a slow holiday period. Consider setting a free FX rate alert here to better time your payment requirements.

GBP/EUR fell to 2-Month lows in late December amidst a sharp drop in European gas prices amidst elevated seasonal temperatures, increases in wind output and increased supplies of LNG gas.

This lowers the odds of energy rationing and the lower cost of fuel will ensure the worst of the crisis is now in the past.

But falling fuel prices have also been experienced in the UK where wholesale gas for January delivery is now trading below levels seen when Russia invaded Ukraine.

This materially improves the economic outlook for the year ahead and could upend the consensus expectation for the UK to be the laggard of the world's developed economies.

Early interest comes from the annual survey of economists by the Times which finds, "Britain is on course to be among the worst-performing of the world's big economies this year".

The 40 economists who took part in the survey were drawn from the City, academia and think tanks and provided their forecasts after the Bank of England's last rate rise of the year in December:

This aligns with a consensus view amongst institutional analysts and is consistent with an ongoing aversion to the Pound.

But the UK currency can still outperform should the consensus be upended.

"A bearish outlook for the UK has pretty much been a consensus view for the past few months, and remains so even as GBP staged an impressive rally against the USD in recent weeks," says Wanting Low, G10 FX, Strategist at Morgan Stanley.

But Morgan Stanley's strategy team thinks this rally by GBP was driven by a combination of positioning adjustment and a broad weakening of the Dollar, rather than a change in the fundamental view.

Driving predictions for UK economic underperformance are expectations for an ongoing energy crisis to crimp growth and ensure inflation remains elevated.

However, "a material fall in energy prices would be a key positive driver, especially as elevated UK inflation is largely an energy story," says Low.

Morgan Stanley lists a Pound rally as one of the ten surprises financial markets could deliver in 2023.

Above: UK wholesale gas for January delivery. Image: Barchart.

As mentioned, UK wholesale energy prices have fallen significantly and many key contracts are now before pre-invasion levels.

Could this open the door to Pound Sterling outperformance in 2023?

"We think a bullish scenario for the UK (and its currency) could come as a surprise to many in 2023," says Low.