Strong Months for GBP – Sterling Update

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GBP

It has been a particularly strong couple of months for the pound, with GBP/USD rising to a 15-month high at over 1.3140 this week, confirming a 6% rally for the pound in that short two month timescale. Of course, much of the rally in cable can be attributed to the weaker dollar, but turbo-charging the appreciation has been expectations that the BoE will be forced to hike UK rates even more aggressively, given persistent inflation here in the UK. The latest inflation data is released next week and will therefore be closely monitored by markets.

The BoE have also been adding to the mix, and in his latest speech at the annual Mansion House Dinner earlier in the week, BoE chief Andrew Bailey reiterated the need for the BoE to meet their mandate of returning inflation to its 2% target level. Here’s hoping, Andy. Bailey also admitted that the UK economy had shown ‘unexpected resilience,’ after the BoE have been forced to increase the pace of UK rate hikes. That ‘resilience’ may be showing up in the ongoing UK growth data, with monthly GDP slipping by 0.1% during May, against an expected decline of around 0.3%. However, one economist called UK growth ‘listless’. Seems a reasonable summary.

In other negative news, the surge in borrowing costs has understandably impacted the mortgage market, with the average 5-year fixed rate mortgage now rising to above 6%, although there have been reports that borrowers have been rushing to push deals over the line in case rates still go substantially higher.

The manufacturing sector also remains fragile, with Industrial Production declining by 0.6% during May, coupled with a 0.2% decline among Manufacturing Production. The ongoing robustness of the UK labour market is also coming under scrutiny, after the latest employment report witnessed a 25.7K rise in claims and the overall ILO unemployment rate increasing from 3.8 to 4%. The cracks are getting deeper.

Back to the pound, and despite those lingering worries over an economic slowdown in the UK, GBP/USD continues to be driven higher by the broadly weakening dollar and those UK rate hike expectations, and not the weakening economic backdrop, so further rallies could be plausible, given the recent move to new cycle highs.

EUR

Much the same as in the UK, the single currency has been on fire of late, with EUR/USD moving all of the way up to above 1.1200, as the pair registers a near 5% gain over the past two months. That represents a 15 month high for the single currency and bodes well for further gains as we move forward. GBP/EUR has remained close to 1.1700 of late, also suggesting that the pound and single currency are moving in tandem, at least for the time being.

A hawkish outlook from the ECB has also continued*, somewhat helping to aid the Euro rally, and with confirmation that Germany’s inflation remains at 6.8%, the ECB will need to persist with rate hikes, despite increasing economic weakness throughout the region, with Germany already in a recession. Markets still fully expect the ECB to hike rates by 0.25% later in the month.

*Confirmed among the minutes of the latest ECB meeting, released on Thursday.

The latest ZEW survey perhaps highlights that economic weakness, with sentiment decreasing markedly throughout the past month. In Germany, the ZEW declined from -8.5, to -14.7, and region-wide investor morale declined from -10, to -12.2. Furthermore, regional Industrial Production has now slipped by 2.2% on an annual basis throughout May.

Therefore, and much the same as in the UK, markets have remained bullish on the single currency for as long as the ECB remain hawkish, but if they show signs of wavering, then further gains for the Euro could be much harder fought.