Only limited GBP upside towards year-end

Karsten Junius October 29, 2021 06:00

In light of the recent surge of the British pound, we have turned a bit more cautious on its prospect. In our view, the currency’s upside is looking rather exhausted, both from the technical near-term and the medium-term rate perspective. Our view is underpinned by the weaker CPI prints for September along with recent developments on the COVID-19 front.

Over the past three weeks, the British pound has pushed markedly higher, gaining around 3% both versus the euro and the US dollar. Hence, from the technical perspective, we would assess the currency’s near-term upside as limited. Based on the 14d Relative Strength Index, the GBP-USD pair now seems overbought.

Clearly, the British currency has largely gained against the backdrop of BoE’s hawkish rhetoric. However, with rate expectations increasing so quickly, there are rising doubts about the sustainability of the recent upward move. Contrary to the 100bp policy rate increase currently priced in the forward market, we expect the BoE to deliver no more than two hikes until the end of 2022. Eventually, the gap between the expected policy rate trajectory and the British pound should narrow, which should moderate substantially the currency’s medium-term appreciation potential. Our case is founded on the September inflation prints published last Wednesday, which came in weaker than generally expected. At 3.1% year-on-year, consumer prices remained largely driven by higher food and energy prices. Given that supply bottlenecks will likely persist for some time, inflation prints should remain elevated over the next months. Yet we expect inflationary pressures to ease from 2Q22, which should help lower the implied policy rate trajectory.

Lastly, we acknowledge that with COVID-related restrictions loosened, the UK continues to be more severely impacted by the pandemic compared to other European countries, despite her 73% nation-wide vaccination rate. So far, the government has rejected calls to re-impose restrictions, but some experts believe new measures may become inevitable as intensive care units have begun to feel the capacity stretch. Reinstatement of restrictions would lead to lower rate expectations, which should weigh on UK’s near-term growth outlook as well as the pound.

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Karsten Junius

Chief Economist, Head Economic Research at Bank J Safra Sarasin