Pound Sterling Tends to Fall in May, but Downside Likely Limited

• GBP has traditionally fallen in May
• Stock market retreat weighs on GBP
• GBP/USD faces midweek test at the Fed
• GBP/EUR could find relief from ECB Thursday

Image © Adobe Images

A cocktail of worries in global markets and a lack of UK-specific drivers means the British Pound is struggling against the Euro, Dollar and others in early May, although the downside is likely to remain limited.

The Pound tracked global equity markets lower as global markets returned from the May Day holidays, suggesting the Pound's traditionally positive correlation to equities is back in play.

"A fresh mix of worries hit stocks hard," says Chris Beauchamp, chief market analyst at IG. "Last week saw risk appetite revive on better earnings from tech giants, but a host of worries about interest rates, further bank crises, the U.S. debt ceiling and of course pre-Fed nerves have conspired to prompt a reversal in equity markets."

"Indices are down sharply, as investors' nerves get the better of them," he adds.

To be sure May is traditionally a month in which the Pound tends to lose value as it has also historically delivered stock market losses; the old adage "sell in May and go away" has historically rung true for Sterling too.

"Sell in May and go away? Seasonal GBP/USD performance: May since 2000" - Convera.

"A potential reduction in profit margins and tighter financial conditions could put downward pressure on earnings. This should weigh on stock-market potential. 'Sell in May and go away' might be a good idea this year," says Daniel Vernazza, Chief International Economist at UniCredit Bank.

If this call is the correct one the Pound could break its recent run of monthly gains against both the Euro and Dollar.

The Pound to Euro exchange rate slipped a third of a per cent to 1.1343 as it gave up the gains made in the final week of April with investors betting Thursday's European Central Bank (ECB) meeting would see another interest rate hike with promises of more to come.

The Pound to Dollar was lower by a quarter of a per cent at 1.2460 with investors seemingly paring bets for Dollar downside ahead of this evening's Federal Reserve policy event which should see another 25 basis point hike announced.

But the market is betting this is the last hike and has been a keen seller of dollars in 2023 as it also expects cuts to commence in H2.

The natural risk is the Fed pushes back against this well-worn trade, resulting in a sharp reversal in the likes of GBP/USD as one-way positioning is exposed.

Traders have meanwhile steadily ramped up 'long' exposure to the Euro over recent weeks on the back of better-than-expected data releases and expectations for further ECB rate hikes.

If the Fed causes markets to reposition, GBP/EUR could bob back up in its well-established range as EUR longs are pared.

More upside risks for GBP/EUR would however come on the back of an ECB day that is not as 'hawkish' as markets were expecting.

A 25bp hike, for example, and a commitment to data dependency could see some of the air let out of the Euro's sails.

From a GBP-specific perspective, downside exposure here is limited as the Bank of England will deliver its interest rate decision and Monetary Policy Report on May 11.

"Sterling's bullish narrative remained intact, suggesting more limited scope for pullbacks," says Joe Manimbo, Senior FX Analyst at Convera. "Britain's economy faring somewhat better than expected is positive for the pound and for prospects for area leading rates topping out at higher levels closer to 5%."

The new month started on a positive note with UK house prices unexpectedly rising, suggesting the Bank of England has scope to raise interest rates by 25bp on two more occasions, thereby closing the gap with the Fed and potentially staying ahead of the ECB.

"Nationwide Building Society reported that its measure of home prices rose 0.5% last month, the first such increase since last August, and matched by a pick-up in mortgage applications. We retain an upside bias for GBP-USD," says Clyde Wardle, Senior EM FX Strategist at HSBC.

HSBC have been bulls on the Pound since late 2022, a position that has proven to be the right one, thus far.

"Confidence has bounced back, and the PMIs are looking better with the forward-looking sub-components, especially promising. On the structural front, the market is no longer fretting about the UK’s fiscal balance, and the core external balance is no longer deteriorating. UK recession fears are now firmly on the back burner," says Wardle.

GBP/EUR support is seen at 1.1270, GBP/USD support is at 1.2340.