Pound feels sick. Forecast as of 25.05.2023

2023.05.25 2023.05.25
Pound feels sick. Forecast as of 25.05.2023

Dmitri Demidenkohttps://www.litefinance.org/blog/authors/dmitri-demidenko/

When bond yields skyrocket, it’s not always good for the local currency. In the autumn of 2022, against such a backdrop, the pound almost collapsed to parity with the US dollar. At the end of spring, history repeats itself. Let us discuss the Forex outlook and make up a GBPUSD trading plan.

Weekly fundamental pound forecast

Back to the past. If in 2022 investors drew parallels with the 1970s in the US, then in 2023, they do it in relation to the UK. At that time, this country was called “the sick man of Europe” due to excessively high inflation and sluggish economic growth. History repeats itself. Despite the slowdown in consumer prices in April to 8.7%, core inflation accelerated from 6.2% to 6.9%. The titanic efforts of the Bank of England are not producing results. The market is demanding an increase in the interest rate to 5.5%, which could eventually turn into a recession. Is the “British disease” back?

There is no result. Despite a total rate hike of 440 basis points since the monetary tightening cycle beginning, inflation had been above 10% for eight out of the previous nine months. In April, it fell to 8.7% but remains at the highest level among most major Western European countries, with the exception of Italy. All forecasts of the Bank of England about the slowdown in CPI didn’t come true. Investors see no reason for consumer prices to return to the 2% target other than a deep recession.

At the same time, the derivatives market is 100% sure that the BoE interest rate will increase by 25 basis points up to 4.75% in June. The chances of the rate growth in 2023 to 5.5% are estimated as fifty-fifty. Bank of America and Nomura expect three more monetary restrictions, and Citi expects two more.

Dynamics of market expectations for BoE rate

Source: Financial Times.

The UK bond yields rally is not surprising. The bond yields are now close to the levels seen at the peak of the Liz Truss government’s mini-budget political crisis in the autumn of 2022. At that time, the pound nearly collapsed to parity with the US dollar due to fears that additional fiscal stimulus would further accelerate inflation and force the Bank of England, with the help of tightening monetary policy, to plunge the economy into recession.

Now the risks of going too far with raising rates, which will provoke a recession in the economy, are also high. Investors are selling out UK bonds, their yields are growing, yield spreads with German papers are widening, and the sterling is falling.

Dynamics of UK-German yield spread

Source: Financial Times.

It is curious that the markets remembered the recession at a time when the Bank of England and the IMF forgot about it. According to the latest forecast of the International Monetary Fund, the UK GDP in 2023 will expand by 0.4%. The estimate is better than January’s -0.5%. Back in April, the authoritative organization talked about the downturn in the economy. In May, the IMF changed its outlook while the real recession risks increased.

Weekly trading plan for GBPUSD

It may well turn out that the Bank of England, with its regular errors in forecasts, is not alone. But the pound will hardly be supported. Under the pressure of lower chances of the Fed’s dovish shift in 2023, the GBPUSD continues falling and has already reached the previously indicated downside target of 1.2365. If the price falls below this level again or rebounds down from resistance at 1.243, there will be more bears. It is still relevant to sell.

Price chart of GBPUSD in real time mode