- GBP rally has faded over recent days
- Following a distinct H1 outperformance
- Barclays (LON:BARC) now bullish on GBPEUR
- Goldman Sachs (NYSE:GS) retains constructive stance
- NatWest (LON:NWG) Markets wary of negative impact of rising mortgage rates
The British Pound was caught in tight trading ranges alongside the rest of the FX field on the first full trading day of the second half of the year but analysts say the British Pound can continue to benefit from a favourable interest rate differential, although others are turning distinctly more cautious on the currency’s prospects from here.
Looking forward to July, some analysts say the high yields paid by UK bonds – while a headache for those refinancing mortgages – can attract international investors to UK assets and support Pound Sterling.
In a new short-term currency outlook note, Barclays highlights the Pound’s carry advantage and its correlation with resilient demand and tight labour markets. However, NatWest Markets is cautious, citing concerns about the potential impact of rising mortgage rates on consumer health and the overall economy.
“We think GBP should outperform as real rates need to move higher,” says Michael Cahill, foreign exchange analyst at Goldman Sachs.
The Pound was the best-performing major currency of the first half of 2023 as it advanced in value against the entire G10 field amidst a better-than-expected UK economic performance and rising interest rates at the Bank of England.
The Pound to Euro exchange rate peaked at 1.1738 towards the middle of June and the Pound to Dollar exchange rate peaked at 1.2848. However, both pairs have since eased back suggesting the rally has entered a phase of consolidation, or, perhaps this is the beginning of a broader decline.
A weekly currency research report from strategists at Barclays maintains a positive stance on the Pound’s outlook as elevated UK interest rates are anticipated to underpin global investor demand for UK assets.
“We have turned more positive on the pound in the near term,” says Barclays, adding they have turned more positive on the Pound to Euro exchange rate in particular.
Driving the constructive sentiment on Pound Sterling is elevated expectations for the Bank of England’s Bank Rate to peak near 6.0% have prompted a rise in UK bond yields, which in turn attracts investment capital inflows.
Research from Deutsche Bank (ETR:DBKGn) reveals an unexpectedly large surge in demand for bonds from domestic retail investors as the Great British public “steps up” to fund an indebted government.
International investors are also coming forward, favouring UK bonds over those where rates are lower in what is known as a ‘carry’ trade, which has the effect of underscoring demand for the Pound.
Sticky inflation and more proactive tightening are to maintain ‘carry’ support for the Pound, says Barclays.
The first half of 2023 has coincided with a shift in stance at the Bank of England from cautious to more assertive in light of persistently stubborn inflation.
“The recent 50bp surprise hike by the MPC points to a (long overdue) more proactive stance against inflation,” says Barclays.
But analysis from NatWest Markets suggests some caution as the Pound will only likely be supported in this high-interest rate environment provided growth remains robust. A high-interest rate but low-growth environment would therefore be unsupportive of the currency’s valuation, which analysts at the bank are wary of in H2.
“Sterling is expected to maintain a large yield premium over the EUR for the next 3 years and have an ever-increasing premium over the USD. The extent to which this supports Sterling will depend on the collateral damage it causes on the UK economy,” says Paul Robson, Head of G10 FX Strategy for EMEA at NatWest Markets.
NatWest Markets recently recommended a short position on the Pound, eyeing its vulnerabilities in light of an expected economic slowdown linked to rising mortgage rates that are anticipated to weigh on consumer health.
But strategists at Barclays meanwhile find that the UK’s inflationary problem is underscored by an economy still characterised by excess demand.
“Although further tightening could ultimately weigh on growth, the UK’s inflation problem is a symptom of resilient demand amid tight labour markets and reduced aggregate supply, in our view. Resilient sentiment surveys support this interpretation,” says Barclays.
Surveys out in June revealed consumer confidence continued to improve with GfK’s much-watched reading showing an improvement for a fifth consecutive month. Lloyds (LON:LLOY) Bank’s Business Barometer meanwhile revealed business confidence rose to a 14-month high in June.
“As such, higher rates will likely enhance sterling’s already considerable carry advantage, even as the bar for further hawkish surprises relative to market pricing remains high. Final PMIs stand out on the data docket this week.”