Pound Sterling Reboot vs. Euro and Dollar Ahead: Bank of America

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The British Pound looks set to reboot its rally against the Euro and Dollar over the coming months according to analysis from Bank of America Merrill Lynch.

Economists at the Wall Street bank expect the Bank of England to keep interest rates at current - or potentially higher - levels for an extended period.

At the same time, central banks in the U.S. and Eurozone will begin cutting rates by as early as mid-2024, creating divergent conditions in monetary policy that can result in downside in the Euro and Dollar.

Currency markets have effectively 'priced in' the end of the global rate hiking cycle meaning the focus has shifted to the profile of rate cuts and those central banks that cut sooner and faster are likely to see their currency underperforma.

Bank of America expects the Bank of England to remain on hold and not cut rates before 2025.

"We think risks skew to further hikes. At the same time, our economists think the ECB is likely done but they expect rate cuts from June 2024, which is well ahead of the Bank of England," says Bank of America.

This creates an apparent central bank policy divergence that would weigh against the Euro while maintaining support for the Pound.

Note that central bank guidance usually shifts ahead of the actual move to raise or cut interest rates, meaning any mid-year cut will be signposted potentially months in advance. Currency movements could therefore begin accounting for these cuts earlier in 2024, or even in 2023.

"We remain of the view the BoE won't help GBP much near term, but a "high for longer" BoE could help GBP vs EUR later — we see EURGBP at 0.85 through our forecast horizon," says Michalis Rousakis, an analyst at Bank of America.

Euro-Pound at 0.85 gives a Pound to Euro exchange rate conversion of 1.1765.

Bank of America meanwhile continues to expect one final hike from the Federal Reserve in November, "but it is a close call".

"We look for the first rate cut in June 2024, with QT to end at the same time but risks for a longer runoff period. Importantly, we look for quarterly 25bp reductions in the policy rate, for a total of 75bp of rate cuts in 2024 and 100bp of cuts in 2025," says Rousakis.

This should result in U.S. Dollar underperformance and give rise to a Pound to Dollar exchange rate forecast profile of 1.24 for year-end 2023 and 1.35 for year-end 2024.