Banks warn of ‘gloomy’ outlook for pound as economy slows

A Wall Street banking duo warn of the pound’s “gloomy” outlook, predicting that stubbornly high inflation and an economic slowdown will precipitate further declines for the British currency.

The pound has lost ground against most of its main rivals this year, despite four interest rate hikes in the UK since December, as the Bank of England began the process of tightening monetary policy ahead of the other major central banks. The biggest losses have come in the past six weeks as investors grow increasingly concerned about a cost-of-living crisis, which the BoE says could push the UK into recession later in 2022. .

The pound has stabilized recently as a broad rally in the dollar reverses, but remains near the lowest level since the start of 2021 against a basket of currencies from the UK’s trading partners.

A recent survey of investors by Bank of America showed the biggest one-month decline in sterling sentiment in at least a decade, abruptly ending a period of relative optimism about the currency.

“Sterling’s fall from grace was epic given the euphoria of the past year and in many ways took the investment community by surprise,” said Kamal Sharma, currency strategist at Bank of America. “Rising rates in the face of a sharply slowing economy is never a good idea for a currency.”

A pause in the global race for the dollar, along with last week’s £15billion package to support UK households battered by rising energy prices, “could bring some relief, but the hurt has done and the outlook for the pound looks bleak,” Sharma added. .

The BoE’s lead in monetary policy tightening has widened the spread in bond yields between the UK and economies, including the euro zone, where interest rates have yet to rise. However, this favorable wind for the pound is about to fade as the European Central Bank catches up, according to Citi head of currency strategy Vasileios Gkionakis.

“The ECB has made a noticeable hawkish turn, while the BoE will remain between a rock and a hard place due to high inflation and a sharp slowdown in the economy,” said Gkionakis, who forecasts a rise in the euro above £0.90 later this year. , from the current level of £0.852.

Pressure on the pound could increase if the UK follows through on its threat to tear up the post-Brexit trade deal for Northern Ireland, Gkionakis added.

The currency climbed as high as $1.42 a year ago as investors warmed to the pound following the signing of the UK-EU Brexit trade deal in December 2020. It has since slipped to $1.26, but losses could quickly accelerate to take the pound. at par with the greenback if the dispute in Northern Ireland escalates into a trade war with the EU, according to Gareth Colesmith, head of global rates and macro research at Insight Investment.

“It could happen, if the UK government doesn’t bluff about Northern Ireland, and pulls the plug, and the US sides with the EU,” Colesmith said.