Recent data shows that the UK economy is increasingly struggling. High inflation is impacting negatively on consumers and this will be causing headaches for the Bank of England’s Monetary Policy Committee. This is weighing on the outlook for sterling and the GBP is facing selling pressure on several major currency crosses.    

  • The economic data deterioration in March shows the Bank of England has a tough job on its hands
  • Interest rate futures markets look to be over-expecting rate hikes
  • GBP selling pressure across major forex. 


March’s data deterioration

As it is almost everywhere around the world, inflation is rising in the UK. In March, headline CPI increased to 7.0% (from 6.2%) and core CPI was up to 5.7% (from 5.2%). Both were significantly ahead of analyst forecasts. 

However, this higher inflation is driven by higher fuel costs, along with higher energy and food bills. These are all factors that hit consumers in the pocket, with fuel prices jumping by around +10% in the wake of the Ukraine war. However, that will not be the worst of it, as a 54% increase to the household energy price cap kicks in for April and is likely to send the headline towards +8% and maybe even higher.

However, the impact is being felt on consumer spending. Consumer Confidence levels have been falling for 5 months in a row and are now down at levels not seen since 2008. Retail Sales fell again in March (sales have only seem month-on-month growth in one month of the past five), with the data also showing a significant miss of expectations.

This deterioration is being reflected in the growth data too. The flash PMI surveys released last Friday point to a “marked cooling” in UK growth into the second quarter of the year. Here is a section from the IHS Markit flash PMI report:

PMI

GDP had already disappointed in February and showed the UK barely growing, by just +0.1%. The first estimate for Q1 GDP may provide further worrying signs for the Bank of England.

All of this will be generating concern in the corridors of the Bank of England. Just at a time at which the fight against inflation is reaching its hardest, a slowdown in growth could turn to recessionary levels of economic activity. The papers are likely to be full of headlines about stagflation if this continues.


UK interest futures still pricing for another 6 rate hikes

According to the CME Group’s SONIA futures curve, markets are priced for another six interest rate hikes in 2022 (taking the Base Rate towards 2.0% by the end of the year). Given the fight that the Bank of England could have on its hands with negative growth in the summer months, we feel that this looks to be priced for disappointment. 

The March +25 basis points increase was considered a “dovish hike”. Another hike is likely at the May meeting. However, five further hikes look to be a big stretch, especially if growth turns negative in Q2.

It seems as though markets are increasingly questioning just how hawkish the Bank of England will be in the face of mounting economic headwinds. 


Forex markets are selling sterling

Almost everything in the major forex space is under selling pressure against a surging USD strength. However, the GBP is especially accelerating lower. Only the commodity currencies (AUD and NZD) have performed worse in the past week.

forex


Major GBP crosses reflect selling pressure

We have seen a crucial breakdown on GBP/USD in the past few sessions. After weeks of holding on to 1.3000 as a support, this floor gave way decisively on Friday in the wake of the Retail Sales data. The breakdown has quickly moved below 1.2850 which was the next level of support and is open for a test of 1.2675. 

Although momentum indicators on the Relative Strength Index (on both daily and weekly charts) are stretched, the reaction around 1.2675 will be a key test for Cable. A closing breach opens 125.15 and potentially even towards 1.2250 as the next serious level of support. With old support at 1.3000 now a new basis of resistance, this will be a barrier to any attempted recovery.

GBP

We are also seeing a significant deterioration in the outlook for GBP against other major crosses. Most notably, we have seen GBP/JPY falling sharply in the past few sessions. Notice in the relative performance graph earlier, the improvement in the outlook for the Japanese yen. This comes as risk aversion has taken hold. A continuation of this trend will see GBP/JPY likely falling away significantly. 

This is reversing a significant gain on the GBP/JPY cross of recent months. A retreat back towards the pivot band 158.00/159.50 should not be ruled out. This is especially the case if market participants on UK interest rate futures considerably pare back expectations of the number of hikes the Bank of England can deliver this year. 

GBP/JPY




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