Currency Forecast - GBP: Pausing For Breath - JUNE 2014

Short-Term Outlook: Having briefly hit a multiyear high of USD1.70/GBP on May 6, the British pound has since retraced back to USD1.67/GBP as of June 2. Given that sterling has posted 10% gains against the US dollar over the past year, a period of consolidation is warranted. This could see the pound drift lower towards USD1.65/GBP in the short term. Moreover, we have previously warned that given the extent of the improvement in the UK economic outlook, with the market expecting GDP growth of around 3% in 2014, much of the good news story has already been priced in which will leave the pound vulnerable to any deterioration in the economic data flow. While softer leading indicator data could weaken the pound somewhat, for the time being we do not expect to see a major fundamental correction and expect sterling to remain above USD1.65/GBP.

Core View: Although we still have concerns about the quality of economic growth (underpinned by consumers running down savings, rather than fixed investment and exports), the UK is still on course to be one of the fastest growing economies among developed states in 2014. Even our below consensus real GDP growth forecast of 2.8% for this year marks a major reversal from early 2013 when the economy was on the edge of recession. Moreover, the UK economy is revving up at a time when the eurozone is still struggling to break out of a prolonged spell of stagnation. Indeed, while UK real GDP growth hit 0.8% q-o-q during the first quarter, the eurozone expanded by just 0.2% and when stripping out a strong performance from Germany (0.8%), the rest of the euro area has disappointed expectations.

Now heading into the second half of the year, there are no tangible signs that the UK rebound is waning. The strength of the headline data, alongside the continued decline in unemployment (both short and long term), and surging house prices have fuelled speculation that the Bank of England is close to normalising monetary policy. We currently have the first bank rate hike pencilled in for early 2016, which is significantly more dovish than market expectations which have settled on Q115. Whether or not we are right on the timing of the first hike, the UK will be one of the first major developed states to begin tightening policy in response to a reduction of excess capacity and a build up of fundamental inflationary pressure. Meanwhile, in the eurozone where both the economic and monetary policy cycles are lagging further behind the US and UK, we expect the European Central Bank to deliver substantial monetary easing in the coming months to ward off the threat of deflation. The combination of weak economic growth and a major new monetary stimulus could prove to be the tipping point for the surprisingly robust euro. Indeed, we have argued that the euro faces the possibility of a fundamental correction, further supporting our multiyear bullish sterling, bearish euro view.

Sterling Pulls Back
UK - Exchange Rate, USD/GBP

This article is part of our Emerging FX Monthly coverage. To access this article subscribe now or sign up for free trial