What is the outlook for the GBP in the second half of this year, and how does it compare to the other top-traded currencies? Giles Coghlan, Chief Market Analyst consulting for HYCM drills down into the detail.
For much of 2022 and 2023, the global economy has been dominated by the impact of the war in Ukraine, surging inflation, and the interest rate hiking cycles of many of the world's central banks. As such, many currencies around the globe have experienced a great deal of flux over the last 18 months.
The GBP is no exception. Having been forced to grapple with domestic economic and political turmoil like September's mini budget alongside the macroeconomic headwinds presented by the global economy, the currency ended last year as one of the weakest-performing currencies in the G10.
That said, the installation of Rishi Sunak and Jeremy Hunt as prime minister and chancellor respectively seemed to steady the ship. As such, the GBP has recovered from last September's low of $1.0856 against the USD to sit at $1.2928 at the time of writing. This means that it's been one of the best performing currencies in the world since the start of 2023.
With this in mind, one might expect the outlook for the GBP to look rather positive for the second half of this year. However, despite the progress that the currency has made in the last few months, the UK economy has the potential to enter a period of low growth and perennially high inflation. Consequently, fears of stagflation in the UK have made the GBP's outlook much less certain.
Evolving expectations
At the outset of this year, the general was consensus that the Bank of England's ongoing interest rate hiking cycle, which had been a focal point of discussions concerning the GBP in 2022, would serve as a tempering mechanism for the UK's CPI data.
As a result, market expectations of a swifter conclusion to the central bank's monetary tightening policy began to grow, especially after the UK avoided a recession and growth came in hotter than expected (0.1%) in January. Growth predictions for the UK were positively updated in line with other major economies, bolstering the outlook for the GBP in 2023 as a result.
However, such predictions were perhaps made in haste. Recent CPI data shows that the UK has a core inflation problem, and it has become clear that the Bank of England will need to cool the economy further, which is why the markets now expect the base rate to peak at 5.75% by the end of this year.
So, what does this mean for the GBP?
The implications for the GBP
Traditionally, one might expect the GBP's outlook to experience something of a bounce on expectations that the Bank of England would need to hike the base rate again, largely due to elevated demand from foreign investors.
However, with inflation as stubborn as it is, investors now fear that should the Bank of England carry out the interest rate hikes that the markets are expecting, the UK will enter a stagflationary period that could mature into a recession. In this scenario, consumers could see their spending power fall, while businesses are likely to be more conservative with their investments, expansion plans or general business activities, thus denting economic growth.
If this were to occur, the GBP would likely experience a mass sell-off from investors, reversing the gains that it has made this year. For this reason, the outlook for the GBP looks much less optimistic than it did at the beginning of the year.
To stay on top of GBP price movements, investors should look to the bond markets, which provide a useful barometer to the health of the UK economy and a potential indicator of the economic path ahead. During the fallout from Liz Truss's disastrous mini budget, for example, the UK gilt markets plunged and forced bond yields to hit nearly 4.5% in October 2022.
It's important to note, therefore, that 10-year yields have been on a significant upward trend in recent weeks, and have recently exceeded the levels witnessed in October. Perhaps due to the threat of sticky core inflation, the markets expect further domestic turmoil for the UK economy in the months ahead.
Contextualising the GBP
So how does the GBP's outlook compare to that of the other top-traded currencies: the USD, EUR, and JPY?
Let's start with the USD, for which the outlook appears to be relatively neutral, despite the fact that it has weakened by 7% since its September 2022 peak. As inflation falls rapidly, the markets now expect the Federal Reserve to signal that it's approaching the end of its hiking cycle in September, while the outlook for global growth has experienced something of a boost in recent weeks, too. The USD should enjoy decent strength in the second half of this year should inflation match expectations and growth data come in hotter than expected, while further dollar positivity could occur if global growth trends remain on their current trajectory.
In the Eurozone, the markets forecast that the ECB is close to ending its monetary tightening cycle, but do not foresee rate cuts in the near-term future - instead, ECB policymakers have clarified that future decisions will be data-dependent. Therefore, t's likely that the continued elevation of the cost of borrowing will be strongly supportive of the Euro until the backend of 2023, provided that the Eurozone does not begin to show signs of stagflation that are similar to those in the UK.
Finally, for the third most traded currency in the world - the Japanese Yen (JPY) - the short-term outlook appears to be relatively strong, but the medium- to long-term outlook is a little more mixed. In the near-term, continued USD weakness and current market sentiment should continue to support JPY. That said, due to the Bank of Japan's (BoJ) ultra-loose monetary policy, the risk factor is that the currency begins to depreciate further down the line if investors choose to capitalise on interest rate differentials. As long as other major central banks continue to hike their rates, this trend could become increasingly likely.
However, with core inflation sitting consistently above 3% for more than a year in Japan, fears of non-transitory could force the BoJ's hand, leading to the bank slowly lifting rates. In turn, this could mean upside for the USD/JPY pairing in particular.
To conclude, the outlook for the GBP remains uncertain given the current economic climate, with the convergence of mounting inflation and the potential for stagflation creating an uncertain environment for investors to manoeuvre in. Consequently, closely monitoring bond markets and diligently tracking economic indicators will be paramount in navigating the ever-changing terrain surrounding the GBP and the other top traded currencies in the coming months.
High-Risk Investment Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. For more information, please refer to HYCM's Risk Disclosure.
Giles Coghlan is Chief Market Analyst, consulting for HYCM - an online provider of forex and Contracts for Difference (CFDs) trading services for both retail and institutional traders. HYCM is regulated by the internationally recognized financial regulator FCA. HYCM is a global brand name of the HYCM Capital Markets Group. The Group via its relevant subsidiaries has representations in Hong Kong, United Kingdom, Dubai, and Cyprus.
*Any opinions made in this material are personal to the person expressing the opinion and do not reflect the opinion of HYCM. This material is considered a marketing communication and should not be construed as containing, investment advice or an investment recommendation or, an offer of or solicitation for any transactions in financial instruments. Past performance is not a guarantee of or prediction of future performance. HYCM does not take into account your personal investment objectives or financial situation. HYCM makes no representation and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by an employee of HYCM, a third party or otherwise.
