Waiting for Inflation to Fall

British Pound Q2 2023 Fundamental Forecast: Waiting for Inflation to Fall

The British Pound is barely above its Q1 opening level with GBP/USD constrained in a six-point, sideways trading range since the start of the year. And this is not really surprising as the first quarter of 2023 has not delivered any major domestic policy moves or economic shocks to steer Sterling decisively one way or another. Interest rates have followed their expected path higher – currently at 4.25%, the highest level since 2008 – while PM Rishi Sunak and Chancellor Jeremy Hunt continue to steer a steady course and have so far avoided the pitfalls of the previous regime. The relationship between the UK and the European Union is also looking healthier with UK MPs backing PM Sunak’s new Northern Ireland deal, overriding Boris Johnson’s contentious Brexit accord agreed upon in 2019.

Inflation in the UK however remains in double-digits – currently 10.4% – a level that in normal circumstances would continue to require ongoing tightening of monetary policy by the central bank. However, according to the latest Bank of England Monetary Policy Report, inflation ‘is expected to fall significantly in Q2 2023’ due to the extension of the Energy Price Guarantee (EPG) announced in the recent budget and the fall in wholesale energy prices.

With price pressures expected to ease sharply, the BoE may not need to hike rates aggressively in the coming months, if at all. The next Bank of England meeting is in mid-May allowing Governor Bailey plenty of time to digest a range of fresh inflation, growth, and jobs data. The latest BoE rate hike probabilities show one 25bp rate hike expected in Q2 before the central bank hits the pause button.

Monthly UK GDP is estimated to have increased in January 2023 by 0.3%, according to updated Office for National Statistics (ONS) data, following a 0.5% decline in December. According to the ONS, monthly GDP is now seen at 0.2% below its February 2020, pre-coronavirus levels. With growth edging higher, and inflation expected to fall, the BoE may hold back on further rate hikes if data permits.

While domestically the UK may seem to be in a state of calm, external factors could quickly change this. Fears that contagion from recent bank failures in the US may creep over the Atlantic remain, while the emergency bailout and forced purchase of Credit Suisse by peer UBS is also ringing alarm bells at the UK central bank. The BoE’s Financial Policy Committee (FPC) recently said that the UK banking system ‘maintains robust capital and strong liquidity positions’ and that in their assessment, ‘the UK banking system remains resilient’.

Looking ahead, the British Pound may continue to move sideways to gently higher against the US dollar. The greenback is under pressure and weakening as traders continue to price in an end to the Federal Reserve’s rate hiking regime.

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