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Can British Pound Cope With Obstacles?

Can British Pound Cope With Obstacles?

Information is not investment advice

Economists say that the Bank of England won’t raise interest rates after May as the UK economy looks set to contract in the second quarter.

Meanwhile, the economic slowdown and a renewed sense of caution at the Bank of England could weigh on the pound’s value, which is already under pressure against the dollar but resilient against the euro. The UK economy grew just 0.1% in February, and obstacles from rising inflation, global uncertainty due to the war in Ukraine, and lockdowns in China make the economic outlook particularly challenging.

A subsequent quarterly decline in Q3 would mean the UK is back in recession just two years after the Covid recession in 2022.

The rise came despite the latest UK GDP data showing a sharper-than-expected economic slowdown in February. The UK GDP was 0.1% compared to 0.8% in January and below forecasts of 0.3%. The pound was supported, however, by rising UK government bond yields, which is often an indicator of rate hikes. The UK 10-year bonds rose 0.09%, outperforming many of their peers, to hit a new six-year high.

Sterling expanded its upside potential on April 12 despite mixed employment data. The UK unemployment rate fell from 3.9% to 3.8%, the lowest level since December 2019. Importantly, the number of vacancies rose to a new record of 1,288,000 from January to March 2022, which should ensure a robust job market even if the rate of job growth continues to slow. However, economic inactivity continued to rise, and wage growth still lags far behind inflation.

Inflation data on April 13 pushed the pound even higher against the euro. The UK CPI was 7%, a huge jump from the previous 6.2% and above the consensus forecast of 6.7%. As a result, the UK government bond yield rose again, hitting a six-year high.

While the Bank of England has been more dovish in recent weeks, markets are betting that rising inflation will force the bank to continue tightening monetary policy.

Protection against a fall in the pound is the Bank of England, which economists expect will raise interest rates again on its May policy meeting. However, the economic downturn makes it look like the Bank will back down from further rate hikes. It will greatly disappoint markets, which expect interest rates to rise to 130 basis points during the rest of the year.

For those hoping for a stronger pound in the coming days and weeks, any resistance to expectations of a BOE rate hike could be disappointing. It would mean a mechanical depreciation of the British currency, all other things being equal.

On April 20, the EURGBP was 0.83000. The support is at 0.82500, the higher resistance level is 0.85130.

The GBP has recovered from the fall in the beginning of the month and now it’s continuing to strengthen.

EURGBPDaily.png

The situation with GBPUSD is different, after plummeting in February, the GBP hasn’t increased higher than 1.33000.

GBPUSDDaily.png

What are perspectives?

While the outlook looks bleak, as shown above, there are some signs of resilience that could mean some positive surprises in the future cannot be ruled out. The British pound is likely to trade depending on where the data goes: a slowdown in the economy is inevitable, but if the economy avoids recession by recovering to growth in the third quarter, the currency could potentially end the year stronger. If the Bank of England justifies the increased expectations of the market regarding the interest rate hike, the pound sterling may maintain support.

UK data is sparse for most of the week, so domestic economic and political news could affect the pound's exchange rate. However, Friday will bring important data. UK retail sales are forecast to contract by 0.3% for the second month in a row, which could hurt the pound sterling.

In addition, instant PMIs for the UK and Eurozone have not been released, which could lead to a significant move if the results surprise the markets. Meanwhile, any news about the Russian-Ukrainian war is likely to also play a role in the GBP/EUR pair. Ukrainian security forces are preparing for new assaults in the Donbass.

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