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Pound Sterling Sees Improved Outlook against Euro and Dollar on Bank of England's "Higher for Longer" Stance Says BofA



{{0|Pound Sterling}} Sees Improved Outlook against Euro and Dollar on Bank of England’s

PoundSterlingLIVE – The Bank of England has succeeded in pushing back against expectations for amongst market participants and this is supportive of the British Pound over the medium- to longer-term, as it lowers the tail-risks associated with a hard landing for the UK economy.

This is according to an analysis from Bank of America (NYSE:) that finds the Bank of England’s August interest rate decision and guidance suggest UK interest rates will stay “higher for longer” although some near-term weakness in the UK currency remains possible.

After two years of rising global interest rates, there is little fodder left for currency markets in the rate hiking story: all the major central banks have reached, or are close to reaching a terminal interest rate, and changes by a few basis points here or there are not game-changing

What now matters for exchange rates is who cuts interest rates first, and by how much.

In this regard, the Bank of England has offered the Pound a hand by pushing back against market expectations for interest rate cuts in 2024.

Mark Wood, UK Economist at Bank of America, says two important sentences were added to the Bank of England’s guidance on Wednesday.

First, it noted that policy is now restrictive and second, that the Bank would hold policy restrictive for long enough to bring inflation down to target.

“These additions suggest the BoE prefers a policy of holding at terminal for longer to hiking more and cutting sooner,” says Wood.

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A look at the interest rate expectations curve, as per money market pricing, reveals the market now accepts higher rates in 2024. For sure, interest rate cuts are still expected, but they are shallower:

This is a supportive development for the Pound if we consider the steepness of the falling curve in 2024 to be important, with a flattening of the curve suggesting less by way of cuts.

The developments align with the views of those economists who suggest the Bank of England’s August policy decision and Monetary Policy Report were relatively ‘hawkish’ in nature, i.e. can be supportive of bond yields and the Pound

“Holding Bank Rate above 5% for longer is not ‘dovish’ in an absolute sense, but it suggested risks of fewer hikes than the market expected and later cuts,” says Wood.

Wood’s colleague, Michalis Rousakis, FX Strategist at BofA, says the Pound can benefit from a steady approach to interest rate policy further out.

Bank of America expects one more 25bp Bank Rate hike in September to 5.5% terminal.

“We expect the first rate cut in February 2025. Today’s guidance and new forecasts from the BoE support our call,” says Wood. “The BoE are shifting away from focusing on where terminal is and towards the policy stance needed over the next couple of years.”

Concerning the Pound’s prospects, Rousakis says a slower and steadier (high for longer) approach “would be a good outcome for GBP by reducing the tail risks of a UK harder landing.”

“For GBP to be supported, we think the BoE should strike a good balance between bringing inflation down to target within a reasonable timeframe and avoiding over-tightening,” he adds.

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However, near-term dynamics do not preclude further weakness as some recent bullish positioning among the investor community still needs to be washed out.

“The lower UK terminal rate and the softer overall Eurozone data suggest more symmetric risks for GBP vs EUR than two months ago, in our view. But we continue seeing downside risks for GBP vs USD in the near term. With Hedge Funds and Real Money being long cable but taking a different stance on according to our analysis, positioning is in line with these risks, we think,” says Rousakis.

Bank of America’s ‘house view’ is for the to be at 1.24 by year-end and 1.26 by the end of the first quarter of 2024, ahead of 1.29 by mid-2024.

Euro to Pound is forecast at 0.85 by year-end with the profile remaining flat for the coming quarters. This equates to a Pound to Euro forecast profile of 1.1764.

Elsewhere, currency strategists at HSBC (LON:) say the Pound’s recent spell of weakness could slow as the Bank of England’s August policy update had sufficient ‘hawkish’ elements to keep the currency supported.

“The decision did represent a somewhat dovish outcome, but there were still some elements of hawkishness in the vote split, the statement, and the forecasts,” says Dominic Bunning, Head of European FX Research at HSBC.

These elements include the two votes for a 50bp hike, by Catherine Mann and Jonathan Haskell, and the statement retaining the line that a “further tightening of monetary policy would be required” if there was evidence inflation was more persistent.

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“On top of this, the BoE’s forecasts for inflation for 2025 increased compared to May’s monetary policy report, despite the new forecasts being predicated on higher rates than those used in May’s projections,” says Bunning.

“We have argued that GBP was looking stretched on the upside in mid-July and have expressed a tactically bearish view on the currency versus NOK in recent weeks. But some of the hawkish elements below the surface of (last week’s) decision may limit excessive downside in the currency from here,” he adds.

An original version of this article can be viewed at Pound Sterling Live



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