Excitement over the GBP’s prospects has cooled recently. The Fed’s hawkish surprise and a wave of risk aversion pressured the GBPUSD lower while the rebound in Covid-19 infection rates in the UK, driven by the contagious Delta variant, is cause for concern.
Source: Our World in Data, Bank of Singapore
We see scope for the GBP to strengthen if the UK economy can fully re-open on 19 July for good. A fully re-opened economy should have positive effects on employment levels and reduce dependence on the government’s furlough scheme, which is due to close out in end-September. Current cheap domestic equity valuations could see international investor flows return to UK equities if domestic activity data continues to improve.
UK PM Johnson has confirmed most Covid restrictions will be removed on 19 July but urged people to exercise "extreme caution" as he sought to end "government by diktat". Ongoing Delta variant concerns could extend the lifecycle of UK Covid leadership narrative, especially if high vaccination rates can prove effective in severing the link between increase in cases and death rates and pressure on hospitals. Health outcomes post UK's Freedom Day will be an extraordinarily valuable guide to other countries seeking to juggle lockdown orders and economic consequences.
Political risks remain but they are unlikely to hold back further GBP gains. Tensions persist with the EU over the implementation of the Northern Ireland protocol. But history suggests that the EU and UK will reach a compromise eventually and Brexit as a theme could stay more as background, not front seat, concern. Meanwhile, another Scottish independence referendum is still far away.
We expect growing impatience with higher inflation as economic slack continues to fade more quickly than expected. The upside surprise to the June UK inflation in the context of a full economic re-opening on 19 July increases the risk of a further hawkish tweak from the Bank of England (BoE) that should keep it in pole position to hike rates earlier amongst the G10 central banks. Whilst this data did not seriously challenge the BoE's 'transitory' inflation view, it highlights the risk that inflation surpasses its expectations by a long way in the short run and raises the risk that this filters through into higher inflation expectations.
Source: Bloomberg, Bank of Singapore
We continue to target GBPUSD at 1.44 in a year’s time although GBPUSD gains could potentially be more limited if Fed tightening becomes increasingly priced in. We forecast EURGBP to fall to 0.84 in a year’s time and stabilise, although we view the risks as skewed towards further downside. Prospects of improving GBP interest rate advantage could remain an important support for the GBP against the EUR and other low-yielding currencies such as the CHF and JPY.Disclaimer applicable to recommendation
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Version: July 2020