Bank of England to Boost Pound Sterling's Prospects against Euro and Dollar With Another Rate Hike: Ebury

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Financial services firm Ebury expects the Bank of England to raise interest rates again before year-end and expects the move to improve the British Pound's prospects against the Euro and Dollar.

Solid economic surveys and last week's upgrade to official GDP data paints a picture of an economy that will avoid recession in 2023 and Ebury's latest forecasts show Sterling is still set to rise against the Dollar while remaining supported against the Euro over the medium term.

"We remain of the opinion that stubbornly high wage pressures and elevated underlying inflation leave the door open to one more UK rate hike in the current cycle. At any rate, these factors are likely to delay the start of BoE rate cuts relative to its major peers, and we do not expect policy easing to commence until the second half of 2024," says Matthew Ryan, Head of Market Strategy at Ebury.

The Pound to Euro exchange rate rose to a high of 1.1562 on Wednesday after September's PMI survey of the economy was revised notably higher to 48.5 from its first estimate of 46.8. The Pound to Dollar recovered to a high of 1.2138.

The disappointing first estimate is said to be one reason why the Bank of England - which had prior access to the report - opted to keep interest rates on hold on September 21, as it suggested the economy was entering a notable downturn that made further rate hikes unnecessary.

Surveys elsewhere are encouraging: the CBI reports today that financial services activity held relatively firm in the third quarter of 2023, despite some softening from a buoyant second quarter. Optimism and business volume growth were quick in the three months to September, although to a lesser extent than the previous quarter, according to the latest CBI Financial Services Survey.

Consumer confidence is meanwhile riding at 20-month highs amidst rising real wages and falling household energy bills. Signs of an economic recession look slim with September's business confidence close to an eighteen-month high and remaining above the long-term average, according to the Lloyds Business Barometer.

The ONS meanwhile raised its previous GDP estimates for the economy which shows it is now well above pre-Covid levels and the UK is no longer the laggard in the G7. "Last week's upward revision to UK GDP data has provided a reason for optimism, albeit a lack of confidence that the Bank of England will deliver additional interest rate hikes has kept the pound pinned around 6-month lows," says Eburg's Ryan.

The British Pound has fallen steadily through the course of August and September as investors dramatically pared back expectations for the scale of hikes still to come from the Bank of England.

Above: The market's expectations for changes in Bank Rate, image courtesy of ANZ.

At one point in mid-summer, the market was looking for Bank Rate to go as high as 6.5%, but the Bank's decision to hold rates in September brought the peak expected by the market to between 5.25% and 5.5%.

A rebound in expectations towards 5.5% - in the event of another rate hike - can therefore support Sterling as it would bring an end to the trajectory of falling expectations and push back against expectations for cuts in 2024.

"While investors see little chance of another BoE hike at the next MPC meeting in November, we are still pencilling in one more rate increase in the current cycle, potentially in December, which we think would be bullish for GBP," says Ryan.

Ebury nevertheless doesn't expect any significant appreciation by Sterling in the current environment.

"Upside in the UK currency does, however, appear relatively limited given the rather bleak economic outlook, and the lingering possibility of a recession in early-2024," says Ryan.

Ebury's forecasters have recently tempered optimism on Pound Sterling following the dovish turn from the Bank of England and revised lower projections for Pound-Dollar. They are nevertheless still pencilling in gains in the GBP/USD exchange rate.

"UK growth is modest, albeit we suspect that activity data will continue to surprise expectations to the upside, which should further buoy sterling. This, we believe, will allow GBP/USD to rally back towards the 1.28 level by the end of 2024, and ensure relative stability in GBP/EUR," say Ryan.