Barclays Predicts "Prolonged" Support for Pound Sterling against Euro and Dollar

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The British Pound is predicted to remain well supported against the Euro and Dollar by one of the UK's biggest high-street banks and international financial services providers.

Strategists at Barclays say the UK's elevated inflation levels are driven by resilient consumer demand amidst a strong labour market which can keep UK interest rates elevated for a longer period relative to key peers, in turn, offering support to the Pound.

The call comes in the wake of the Bank of England's August policy decision that saw a 25 basis point interest rate rise accompanied by an apparent commitment by policymakers to keep interest rates at elevated levels for a prolonged period, which some currency analysts say is a supportive development for the Pound.

The Bank said this was a recognition of the UK's strong labour market that has underpinned high core inflation levels which are unlikely to fall back quickly, precluding the potential for any interest rate cuts in the medium term.

Elevated UK interest rates relative to elsewhere should, in turn, boost the Pound: "carry support in place for long following the smaller August hike," says Sheryl Dong, a foreign exchange analyst at Barclays.

Dong and her team turned positive on the Pound's prospects midyear after the Bank of England surprised markets by raising interest rates by 50 basis points, which was a larger hike than market participants had been anticipating.

Although the downshift to a 25bp move was deemed as a dovish development by some analysts, including Goldman Sachs who lowered their Pound-Euro forecasts as a result, Barclays reckons the 'higher for longer' message is where the cream is to be found.

"Last week's 25bp hike by the MPC may have failed to trigger a break-out higher for the pound, but it added to already ample carry support," says Dong. "The MPC is now explicitly acknowledging that policy is in restrictive territory, but more hikes are still likely."

Above: The odds of rate cuts in 2024 have declined, even as the peak in Bank Rate expectations has shifted lower. Image courtesy of Goldman Sachs.

Economists at Barclays are now predicting one more interest rate hike, albeit with large uncertainty both ways given the Bank's data dependency.

This leaves a greater-than-usual emphasis on August 16's inflation data release, which will push rate hike expectations higher if it beats expectations. But a below-consensus reading would trigger a further lowering of expectations for the peak in Bank Rate, potentially weighing on the Pound.

But Barclays thinks the message from the Bank is that policy restrictiveness is likely to remain in place for long.

"This implies prolonged sterling support from high rates (both in absolute terms and versus peers), even as the terminal rate will likely be lower than what was priced only a few weeks ago," says Dong.

Barcalys' broader assessment is that the UK's inflation problem is a symptom of resilient demand amid tight labour markets and reduced aggregate supply is consistent with this outlook.

Analysts predict the Pound to Euro exchange rate will remain within last year's tight range and envisage a modest upside for the Pound to Dollar "as the euro grinds closer to its fair value".