Pound Sterling: Prudent to Book Some Gains against Euro and Dollar Ahead of CPI Inflation Release, Bank of England

Above: GBP performance in the week ending June 16 shows gains against all major rivals.

The British Pound has risen to fresh multi-month highs but the coming week could result in a setback if inflation data surprises either higher or lower and the Bank of England strikes a cautious tone on Thursday.

Ahead of these events momentum trends appear firm for both GBPEUR and GBPUSD, suggesting further gains could be possible and those with payment requirements should keep in mind it is often futile to actively guess the top in a trending market and position for a reversal.

"Sterling has been the strongest of the G10 currencies over the last 6 months, as it has continued to recover from last year’s political and confidence crises. Q4 last year saw a series of downward revisions to UK growth forecasts, which have been partially reversed since then as the worst fears about the economy haven’t materialised," says Kit Juckes, head of FX research at Société Générale.

The Pound to Euro exchange rate (GBPEUR) on Monday reached its strongest level since August 2022 at 1.1738 and 1.1765 (or 0.85 EUR/GBP) appears to be a key technical objective for bulls ahead of the multi-year peaks that reside around 1.20. "Pound sterling remains well supported by rising rates and we recently revised our 3-month forecast to EUR/GBP 0.85," says David Alexander Meier, an analyst at Julius Baer, the Swiss-based private bank.

The Pound to Dollar exchange rate (GBPUSD) rose to its highest level since April 2022 at 1.2848 on Friday and is at 1.2823 at the time of writing.

The strength of the GBPUSD rally makes calling a technical ceiling difficult at this juncture but a number of analysts we follow say the 1.30 level appears to be an objective for the near-term. "The pricing of a further 5 25bp rate increases in the UK this year (to a peak just below 6%), is dragging GBP/USD towards 1.30," says Juckes.

Pound Sterling has been boosted by rising short-term UK bond yields which in turn reflect expectations for further Bank of England rate hikes, owing to the UK's 'sticky inflation' problem.

Therefore the immediate risk to the Pound Sterling uptrend lies with the CPI inflation report on Wednesday, June 21 where a downside miss could see Bank of England rate hike expectations deflate, which would prompt an unwind in GBP strength.

The Bank of England then delivers its next hike the following day on June 22 and could introduce some 'dovish' guidance on any inflation undershoot; after all the Bank will be eager to bring an end to its hiking cycle to avoid prompting a deep recession.

"Our conclusion is that in addition to next week, the MPC will raise the Bank rate in August and September resulting in a terminal rate of 5.25%. Previously we had expected the Bank rate to peak at 4.75%. Our baseline case is that rates will not rise as far as 6%, but policymakers are currently in a state of heightened data dependency and we note that significant risks exist in both directions," says Philip Shaw, Economist at Investec.

Above: GBPUSD and GBPEUR (bottom) at weekly intervals.

From a risk management perspective, clearing some FX exposure at current rates would therefore represent a hedge against any downside surprises from the pivotal events this week brings.

Brad Bechtel at Jefferies, the investment bank, says the Bank of England is dealing with an even harder situation than the ECB or Fed given their inflation numbers look far worse in the UK.

"Growth is holding up well despite the inflation figures and cost of living impact and the expectation is that the BoE will reluctantly keep hiking. GBP will remain better bid vs. USD, EUR and JPY for now," he says.

But another risk would be inflation coming in well above expectations, a counterintuitive position to what has already been written above regarding the impact of below-consensus inflation.

This is because there is a risk an inflation blow-out could prompt a surge in bond yields (pushes up mortgage rates etc) and raises the prospect of a deep recession forming at some point in the coming months.

Such an outcome could be GBP negative.

So for the immediate term, an on-target inflation print would likely be required to underpin the Pound's uptrend against the Euro and Dollar.