British Pound Q3 Fundamental Forecast

BRITISH POUND (GBP) FUNDAMENTAL OUTLOOK

l The Bank of England expects the UK economy to grow by 7.25% this year.

l UK inflation is likely to exceed 3% for a temporary period.

The UK economy looks to be in rude health with economic growth picking up sharply over the last quarter. According to the latest Bank of England (BoE) report, the recovery in economic activity is ‘most pronounced’ in the consumer-facing services sector after Covid restrictions were loosened in April, with output in some sectors ‘around pre-Covid levels’. The BoE expects the UK economy to grow by 7.25% this year, supported by the successful vaccination program and continued unwinding of lockdown measures, while the Confederation of British Industry (CBI) is more bullish and expects UK GDP to grow by 8.2% this year and 6.1% next year.

This bullish backdrop may come under pressure when the Governments furlough scheme ends at the end of September. The Office for National Statistics (ONS) said recently that the percentage of workers on furlough has dropped from 20% in late January this year to 7% in late May, although this still leaves 1.5 million workers on the scheme. The end of Q3 will be an important time for the government if they are to get unemployment back down to pre-covid levels.

Price pressures in the UK are also pushing higher with annual inflation hitting 2.1% in May, above the central banks target. The BoE expects inflation to exceed 3% for a temporary period, driven higher by energy and commodity prices. This outlook has prompted the market to bring forward thoughts of UK interest rate hikes, although if the recent developments in the US are anything to go by, the BoE will hold back on hiking rates until hard data makes it difficult to avoid.

UK data releases will now play an even more important role in any trading setup with the BoE becoming increasingly data-dependent. While most official data is backward-looking, the confirmation or not, of a trend in growth, employment or inflation, will be used as justification for any moves in monetary policy. The BoE will focus on inflation over the next few months and while they currently see the overshoot as temporary, they must be careful not to paint themselves into a monetary policy corner if price pressures become increasingly sticky.

Over the past two quarterly reports, we have been cautiously optimistic about Sterling and remain so, though we do recognise that the best performing quarters may be behind us. The British Pound may struggle to move meaningfully higher against the US dollar as expectations of tighter monetary policy in the US grow. Sterling may have a better chance of appreciation against other currencies, especially those for countries that are expected to keep monetary policy loose. Traders looking for bullish Sterling plays may be minded to look at GBP/JPY or EUR/GBP, while GBP/CHY may soon break out of its recent trading range.