Pound Sterling: Analysts say too Soon to Call the End of the Rally against the Euro and Dollar
- Written by: Gary Howes
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It was a 'hawkish' Bank of England update delivered on Thursday, one that would be expected to yield further gains in the British Pound, however, the currency ultimately retreated against the majority of its major peers.
The outcome validates a preview piece Pound Sterling Live published ahead of the event in which we reported the odds of the currency ending the day lower were set as high as 90%.
The key issue noted ahead of the Bank of England's May decision and Monetary Policy Report was the Pound's rally was looking rich and some giveback was required, whatever the tune coming out of Threadneedle Street.
Therefore, the Pound could be undergoing a rebalancing within a broader uptrend that could ultimately extend over the coming weeks.
"The reaction of sterling has been interesting. The initial rise of a third of a per cent was wiped out by a triple-digit fall before the end of the day, taking GBPUSD back to 1.25. The market players continued to pocket profits after the Pound's rally since early March, recalling the adage 'sell in May and go away'," says Alex Kuptsikevich, senior market analyst at FxPro.
The Pound to Dollar exchange rate (GBPUSD) traded as high as 1.2640 in the immediate wake of the interest rate hike before closing the day at 1.2509. The Pound to Euro exchange rate (GBPEUR) meanwhile ascended to a multi-month best at 1.1545 before closing out at 1.1456.
At the time of writing ahead of the weekend, the pairs are at 1.2493 and 1.1480 respectively.
Kuptsikevich says the Bank of England is now benefiting from the appreciation of its currency against its main rivals, as rising import prices significantly contribute to inflationary pressures.
"As such, we expect the Bank of England to adopt more hawkish rhetoric than the Fed in the coming months, which will support the GBPUSD to rise to the 1.30 area after the correction of the recent rally with a pullback to 1.2350," he adds.
The Bank hiked by 25 basis points and said in a statement it sees a risk of persistent price and wage-setting behaviour, suggesting policymakers are increasingly wary of a potential wage-price inflationary spiral and inflation persistence could require further tightening.
"A more favourable economic outcome of low growth rather than recession and tight labour market conditions were noted. Guidance remained hawkish – if high inflation persists, they will tighten policy further," says Robert Rennie, a currency strategist with Westpac.
The Pound is the top-performing G10 currency of 2023 as investors reassess their assumptions regarding the UK and UK assets following a string of better-than-expected economic outcomes.
The economy has not fallen into recession - as the Bank of England so often predicted in 2022 - prompting a readjustment higher in the Pound.
Another rate hike in June could ultimately ensure Sterling remains supported near-term. "The Bank of England hiked by 25bp and left the door open for another hike in June due to a continued high wage and inflation pressure. We have pencilled in another 25bp hike in June in our expectations, marking the peak bank rate at 4.75%," says Bjørn Tangaa Sillemann at Danske Bank.
But downside risks lurk with this month's jobs report (May 16) and inflation (May 24) likely to be pivotal in determining whether the Bank raises interest rates again in June.
If data undershoots on these two dates then we can expect investors to pare back Bank of England expectations, prompting a retracement in the Pound.
"While we don't exclude one final June hike, our base case is that we have reached the peak of the BoE tightening cycle as inflation will start to rapidly decelerate this year," says Francesco Pesole, FX Strategist at ING.
"The Sonia curve continues to price in around 38bp of tightening to the peak,
which leaves the pound at risk of a rate-driven negative impact down the stretch," he adds.
ING say they expect a material decline in the Pound versus the Euro, pencilling EUR/GBP to rally back to 0.90, which places GBPEUR at 1.11.
But for now, Pesole doesn't see any reason to bet against the Pound.
"There aren’t many convincing reasons to call for GBP underperformance against its main peers in the near term," he says in a daily currency briefing note.
