Will the UK Avoid a Recession? – Sterling Update

GBP

As expected, the Bank of England (BoE) delivered a twelfth successive rate hike yesterday (Thursday), raising UK interest rates by another 25bps to 4.5%. At 7-2, the voting pattern was also the same as last time round, with Swati Dhingra and Silvana Tenreyro once again voting for a pause.

The BoE also significantly revised their short term UK inflation outlook higher, admitting that they had underestimated the strength and stickiness (sorry) of food price rises. The BoE now think that UK inflation will not reach their 2% target until early 2025. They had previously expected inflation to subside to that level within a year.

On a positive note, the BoE now think that the UK economy will avoid a recession, with GDP expected to reach 0.25% throughout this year, and then surging by 0.75% during 2024. Gone are the days when Andrew Bailey was predicting a long drawn out recession in the UK, and whilst growth may not be anything to write home about, growth at any level is something to cheer about.

Given that headline inflation remains in double digits, markets still expect the BoE to be forced into further rate hikes, with those changing rate dynamics one of the key drivers sparking the recent rally to a one-year high in GBP/USD. The expected terminal rate is now at 5%, which would imply another 2 further hikes from the BoE. While the pound may have witnessed some profit taking after the BoE, those implied rate hikes could help to keep the pound elevated in the longer run.

In the meantime, GBP/USD dropped from over 1.2600, to just under 1.2500 yesterday afternoon, a move which was aided by broader market risk aversion and profit taking/position squaring after the event.

Looking ahead, next week should confirm another solid UK employment report, with ILO unemployment predicted to remain at (or near) 3.8%.

EUR

With the ECB having raised Euro area rates by another 25bps last week and signalling further hikes to come, one may have assumed that the Euro would continue rising, but the single currency has since struggled to maintain its impressive recent rally, with EUR/USD slipping from a high of just under 1.1100, to around 1.0900 by yesterday (Thursday).

Markets seem unconvinced that the ECB will persist with rate hikes for much longer than the Fed, which may be impacting the short-term profile for the single currency. Recent commentary from ECB officials has also left more questions than answers, with a more cautious view on future rate hikes from the ECB’S Nagel, even if the likes of Lagarde and Kazaks have maintained their own hawkish outlooks.

On the data front, the latest release of German inflation saw Harmonised inflation remaining at 7.6% on an annual basis. Regional inflation is expected to remain close to the 5.6% region when released next week. The latest growth data is released next week too, with provisional regional growth predicted to have risen by 0.1% during the first quarter of this year and 1.3% on an annual basis.

Back to the Euro and overall market risk sentiment will play a big part in dictating the short-term profile for the single currency. If markets remain twitchy, then this will likely feed through to a weaker Euro and vice-versa.