Foreign exchange analysts at Rabobank have revised lower their near-term (one-month) Euro to Pound (EUR/GBP) exchange rate forecast to 0.86 from 0.87. This equates to a conversion of 1.1627 for the Pound to Euro (GBP/EUR) exchange rate.
As a reference, the current live Euro-Pound rate is 0.85527 and the live Pound-Euro-rate is 1.1698.
However, the strategists keep their longer twelve-month view at EUR/GBP 0.90.
While the British Pound (GBP) is experiencing an uptick influenced by persistent inflation and strong labour data, potential risks such as rising recession fears could hinder its continued growth, according to the latest analysis from Rabobank.
Inflation concerns continue to plague the UK, with the Bank of England (BoE) under pressure to reassess its monetary policy measures to bring inflation back to its 2% target.
"The UK economy has an inflationary problem which is far stickier than its peers," says Jane Foley, Senior FX Strategist at Rabobank.
The unexpected resilience of price pressures is pushing the bank to contemplate more decisive action.
"Price pressures are taking a 'lot longer' than [BoE Governor Bailey] had hoped to come down," she adds.
While this has prompted an upward revision of the GBP forecast, Rabobank points out that the precariousness of the UK's economic backdrop, exacerbated by looming recession fears, could deter investors and consequently impede the Pound's growth.
Market Anticipates Continued Inflation Overshoot
UK inflation, consistently exceeding market expectations and standing well above its Eurozone and US counterparts, has raised alarms.
Foley highlights this trend, stating, "The official CPI inflation data has developed a tendency to overshoot market expectations."
This sustained above-target inflation is likely to persist until mid-2025, according to IMF warnings relayed by the Rabobank strategist.
These concerns, Foley says, are mirrored in the restrained forecasts for UK's May inflation.
Some market participants now anticipate the BoE to reveal a more substantial 50 basis points move, in contrast to the consensus figure of 25 basis points.
This expected inflation trajectory, coupled with the BoE's potential reactive measures, underpins the upward revision of Rabobank's GBP forecast.
Labor Market Dynamics Influence Inflation
A tighter labour market, reflected in the unexpected 6.5% y/y rise in April average weekly earnings, is fuelling fears that the BoE may need to enhance its anti-inflation efforts.
"Governor Bailey yesterday called out firms who are hoarding labour despite slowing demand," Foley observes, attributing this to post-pandemic hiring difficulties and worker shortages in certain sectors.
Monetary Policy Committee’s (MPC) newest member Greene's concerns about 'second round' effects creeping into inflation signals potential destabilisation of inflation expectations.
"Greene has also suggested that she agreed with the Bank’s decision to hike rate last month," says Foley.
These observations by MPC's Greene underline the complexity of the inflation situation and the BoE's possible heightened response.
GBP/EUR Exchange Rate Performance Amid Economic Challenges
Despite recent GBP gains against both the USD and EUR, the analyst highlights potential roadblocks that could derail the Pound's positive trajectory.
As higher short-term interest rates continue to support the currency, the GBP's performance is scrutinised in the light of the UK's weak growth, high inflation, high debt, low investment growth, weak productivity growth, and a current account deficit.
These fundamental factors inevitably raise the risk of increased debt distress.
"If the market begins to assess that the Bank may have to push the economy into recession in order to push CPI inflation back to 2%, GBP could begin to falter despite the higher rate environment," Foley warns.
Despite the challenges, Rabobank has revised its 1-month EUR/GBP forecast from 0.87 to 0.86.
Nonetheless, the bank retains a 12-month view that predicts a potential risk of EUR/GBP reaching 0.90.
"We still see risk of EUR/GBP0.90 on a 12-month view," Foley discloses.
Potential Recession Looms Over Pound Sterling Strength
The evolving economic landscape, defined by higher inflation and stronger labour data, has so far contributed to the GBP's resilience.
However, the possibility of the BoE having to instigate a recession to curtail the inflation rate is emerging as a potential risk factor.
"If the market begins to assess that the Bank may have to push the economy into recession in order to push CPI inflation back to 2%, GBP could begin to falter despite the higher rate environment," Foley emphasises.
Thus, while the BoE's potential hawkish shift could initially support the GBP, the longevity of this strength is contingent on the UK's ability to navigate its economic challenges.
If recession fears become more prevalent, the momentum behind the GBP could be substantially undermined.
Yet, even in the face of these potential headwinds, some market participants have shown continued confidence in the GBP.
A streak of better-than-expected UK economic data earlier in the year appeared to lessen fears of a lengthy recession.
This optimism sparked a round of short-covering in GBP positions.
"CFTC data suggest that speculators have now held long GBP positions for eight consecutive weeks," Foley points out, indicating continued confidence in the currency despite potential risks.
