A big week ahead – Sterling Update

GBP 

The pound has been contained within a fairly tight trading range over the past week, with GBP/USD only briefly moving below 1.2300 (low 1.2263), whilst also failing to break over 1.2450 after several attempts. The latest batch of data releases have hardly helped the pound’s cause, with December’s data for UK public sector borrowing reflecting the accelerating cost to the government of both ongoing debt interest payments, and energy bill assistance programmes. The former saw the government having to foot a painful £17.3bn bill through December alone, a figure clearly impacted by those ongoing BoE rate hikes.  

Overall, government public sector net borrowing hit £24.7bn through the past month (a December record), nearly £15bn more than the same month a year ago, and £7bn more than had been earmarked by analysts. It is not all doom and gloom, however, with the latest factory price data helping to boost signs of softening in inflation, which may help to cap the ultimate terminal rate for the BoE, as well as softer energy prices since the summer helping to reduce the government’s cost with assistance programmes. These factors should help to smooth overall borrowing costs as we progress through the spring. The latest PMI readings also reflected some softness versus expectations in the composite and services components, although there was a surprising beat for manufacturing.  

Next week will be dominated by the first BoE meeting of the year. It is a tough balancing act for Andrew Bailey and the rest of the MPC, on the one hand inflation is softening, but by no means anywhere near where it needs to be at. However, the UK has been struggling against a wall of negativity, with huge increases already to the cost of living and what seems like half of the country out on strike at any given moment. Further hikes in rates will only make the tough times even tougher for those that need it the most, as higher interest rates add to their woes, so after what is likely to be another 25bps rate hike, further hikes may be a tough ask.  

As for the pound, well the powerful trend of a weakening dollar and that surging EUR/USD (see EUR) will help to ensure that GBP/USD may remain buoyant for the most part. A move over 1.2500 looks the next big challenge for the sterling bulls to attack. GBP/anything else is another matter, and given the weak backdrop, the pound may find the going a little tougher, especially against the resurgent single currency.  

EUR 

It has been a strong start to the year for the single currency, with better data for the region helping to underpin the ongoing commitment from the ECB to maintain their aggressive path of rate hikes. That set of improving data really has helped the cause, with the latest PMI readings (mostly) beating estimates and reflecting solid improvements. Both German and Euro area services PMI’s are now above the key 50 (economic expansion) territory, reflecting increased optimism. Strong gains in the German ZEW survey also highlighted improving sentiment and business conditions.  

Talking of increased optimism, German Chancellor, Olaf Scholz, bravely predicted this week that Germany will now avoid a recession. Of course, with spot gas prices now running at about a third of the level they were at their peak, the predicted commitment that the government in Germany would have had to made to assist consumer energy bills, will now be a fraction of previous estimates. With signs of recovering manufacturing and consumer optimism increasing, the chancellor may well be onto something.  

Christine Lagarde and her team at the ECB are still using every opportunity to highlight the need for further 50bps rate hikes, and markets now fully expect that the ECB will raise rates in the Euro area by 100bps over the next couple of months. Contrast that against a Fed that may hike US rates by 50bps (at most) during the same period, and it is easy to see how rate dynamics have shifted in favour of the single currency.  

That has all helped to underpin the move in EUR/USD, and gone are the days of talk of test of parity again, most analysts are now predicting the next move to be a test of the 1.1000 region. Saying that, the single currency has struggled to hold onto gains above 1.0900 over the past week. GBP/EUR has not quite played to the same tune, and having slipped to test support at 1.1300, rallied back over 1.1350 alongside the recovery in GBP/USD (see GBP).  

Next week sees the release of both German and region-wide inflation, data which could well add further support to the ECB’s argument to remain hawkish.