Pound Sterling: A Crucial Week as Downside Pressures against Euro and Dollar Start to Build

• GBP retreats ahead of key inflation, wage data
• Markets see ~80% chance of another BoE hike
• Soft data would see these odds retreat
• Potentially weighing on GBP
• Wage data due Tuesday inflation due Wednesday
• Retail sales and flash PMIs end a data-heavy week

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The British Pound remains near the previous week's lows against a host of major currencies as investors limit exposure to the currency ahead of a number of key data releases.

The Pound faces a data-heavy week that will set up the Bank of England's May interest rate decision with labour market and inflation releases dominating the docket ahead of Friday's retail sales.

The Pound to Euro exchange rate slid by 0.80% last week to 1.13 as investors bet the Bank of England would deliver less by way of interest rate hikes than the European Central Bank over the remainder of 2023, an expectation that would be confirmed if Tuesday's wage numbers come in below expectation.

To be sure, wage pressures have been easing in the UK over recent months but the market still looks for the headline figure (bonuses included) to read at an inflationary 5.1%.

Any disappointment here could underscore the Pound to Dollar exchange rate's recent pullback from multi-month highs above 1.25 towards 1.24 and raise expectations a peak has been reached.

"The labour market has recently displayed a degree of resilience in the face of a flat economy, albeit with some signs of loosening around the edges. We expect this to have remained broadly the case in early 2023," says Andrew Goodwin, Chief UK Economist at Oxford Economics.

Wednesday's inflation reading will likely set the tone for the Pound into May if it comes in below the market's expected 9.8% year-on-year reading.

"OIS pricing implies about an 80% probability of a 25bp hike in May. We see this, like with the Fed, as an unnecessary rate hike given the evidence of declining inflation pressures," says Derek Halpenny, Head of Research Global Markets for EMEA at MUFG. "While the pound has performed well this year, data this week may have weighed on near-term performance."

It could, however, be the core inflation print (expectation: 6.0%) and the services sector inflation print (no estimate given) that will excite markets.

Again, a stronger-than-expected reading would elicit some strength in Pound exchange rates as investors become more confident the Bank of England will raise rates again, but a miss would underscore recent declines.

"After CPI inflation unexpectedly rose in February, we think the previous downward path resumed the following month," says Goodwin.

Oxford Economics estimates that much of the increase in the CPI measure to 10.4% in February was due to price rises in the restaurants and hotels and food and non-alcoholic drinks categories.

"Prices in both sectors are likely to have been pushed up by poor harvests that caused shortages of salad products, but that impact should have begun to fade in March," says Goodwin. "More importantly, base effects, particularly in relation to the cost of fuel, will have exerted a sizeable drag."

Foreign exchange analysts at Barclays say high and sticky domestic inflation along with strong wage growth data should make the BoE relatively less dovish versus G10 peers.

"This leaves sterling range-bound around current levels versus the euro, whose macro exposures and monetary policy outlook are somewhat similar, and on the front foot versus the dollar, where
monetary policy tightening is approaching its terminal rate, in our view," says Themistoklis Fiotakis, an analyst with Barclays.

The Pound will be less sensitive to retail sales, although a big deviation from expectation could nevertheless trigger a move ahead of the weekend.

The market is looking for retail sales to have shrunk 0.5% month-on-month in March.

A beat on expectations could convince the market the Bank of England will go with another 25 basis point hike in May, potentially supporting Sterling.

"Retail sales growth in January and February pointed to a retail revival, with sales volumes increasing 0.9% m/m and 1.2% m/m respectively, taking the level of sales to a six-month high. With consumers still facing serious cost of living pressures, retail sales may have given up some of those gains in March," says Goodwin.

He says this is a possibility supported by relatively subdued results from retail surveys by the CBI and the BRC.

Oxford Economics forecasts a 0.1% m/m drop in sales volumes in March which would disappoint against market expectations and weigh on the Pound.

Flash PMI data also have the potential to impact the Pound as they are the most timely and well-respected of the surveys.

The PMI's follow the release of retail sales and come out at 09:30 BST, making Friday a busy one for UK data-watchers.

"April's set of flash PMIs are likely to remain consistent with private sector activity continuing to grow modestly. The more forward-looking balances of the previous month's S&P Global/CIPS surveys were relatively upbeat and a calming in concerns around banking sector turmoil in the US and elsewhere may have supported survey respondents' sentiment," says Goodwin.

The market looks for the manufacturing PMI to come in at 48.5, services at 53 and the composite at 52.6.