Barclays: Risk Pound Sterling Comes Under Pressure vs. Dollar but Better Supported against Euro

- Barclays maintain broadly supportive view on GBP
- GBP/USD upside likely limited
- But GBP/EUR can go to 1.20 over coming months

Pound coin

Image © Pound Sterling Live

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The British Pound is expected to remain supported over coming weeks and months by analysts at Barclays, but they say a repeat of those rapid gains seen in early 2021 is unlikely.

The UK high street lender and international financial services provider says the Pound will see differing performances against the Dollar and Euro, with strength in the former likely to keep the Pound-Dollar exchange rate close to 1.40.

"GBP remains well supported by its leading vaccination effort, growth outperformance, and longterm undervaluation although further upside is likely more limited given its outperformance since last fall," says Marek Raczko, a foreign exchange analyst with Barclays.

Barclays say in a regular monthly foreign exchange market research briefing that they expect some appreciation by Pound Sterling ahead, followed by range trading.

Keeping the currency supported is an expectation for a continuation of a robust post-pandemic economic recovery which will in turn prompt the Bank of England (BoE) to raise interest rates, which markets currently expects to happen in 2022.

Foreign exchange markets are showing heightened sensitivity to central bank policy, favouring those currencies belonging to central banks that are ahead in the process of normalising interest rate levels.

On this count the BoE offers a relatively supportive stance for further Sterling appreciation given UK inflation has already breached their 2.0% target and the country's labour market is proving more robust than many economists had expected.

Pound vs Euro and Dollar

Above: GBP/USD daily (top pane) and GBP/EUR daily lower pane. 

The BoE at their June policy meeting upgraded their forecasts for the UK economy and delivered guidance consistent with a first rate rise in 2022 as they expect the economy will have largely recovered to pre-pandemic levels while the recovery is expected to be underpinned by an effective vaccination campaign.

But the U.S. Federal Reserve (Fed) is unlikely to be left too far behind the BoE in this regard, with projections from the June meeting of the Federal Open Market Committee (FOMC) showing a rate rise is now likely in 2023 and not in 2024 as had been previously expected.

This shift in expectations has prompted a period of short-term U.S. Dollar outperformance as investors move to price in earlier-than-expected interest rate hikes at the Fed.

In fact, the Dollar is the best performing major currency of the past month as a result:

Dollar performance past month

Above: Relative performance of the Dollar over the past month.

FX transfers: Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more. (Advertisement).

"In addition to the US being the fastest-growing economy within G10 and most EM, the post- FOMC adjustment in US real yields is likely to lead to some USD firming in the near term," says Marvin Barth, an analyst with Barclays.

With the BoE and Fed both moving in a direction that is supportive of their respective currencies the potential for deadlock in the Pound-Dollar rate increases, while a more hasty Fed could drive unexpected Dollar outperformance.

"We also expect the BoE to move in line with the Fed and slowly signal some monetary policy normalisation. However, we see a risk of GBPUSD coming under pressure if we observe earlier tightening of monetary policy from the Fed not matched by the BoE," says Raczko of the Pound-Dollar outlook.

Barclays forecast a steady Pound-to-Dollar exchange rate over coming months, expecting the pair to be at 1.40 by year-end right through to the end of the third quarter 2022.

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GBP/EUR Forecasts 2021

Period: Q2 2021 Onwards
Details: Consensus institutional forecast targets + max & min targets.
Contributors: Citi, Barclays, Morgan Stanley & more
Provider: Global Reach
Type: Free Download
Please Access Here

Smaller banner

GBP/USD Forecasts 2021

Period: Q2 2021 Onwards
Details: Consensus institutional forecast targets + max & min targets.
Contributors: Citi, Barclays, Morgan Stanley & more
Provider: Global Reach
Type: Free Download
Please Access Here

But against the Euro the Pound is expected to deliver more discernible gains.

"The EUR continues to bring up the rear among our G10 forecasts, as its economy lags its peers and monetary policy faces no realistic chance of normalisation within the next few years," says Barth.

Barclays joins other institutions who say divergence between BoE policy and that at the European Central Bank (ECB) is expected to be a key driver of Pound-Euro exchange rate movements in the future.

The ECB looks set to only raise interest rates in 2024, which suggests the return offered on holding UK government bonds by international investors should eclipse those on offer in the Eurozone.

Economists expect such a divergence to create capital flows that prove supportive of the Pound.

"While the economy is expected to bounce back vigorously over the next year, it is only catching up after a larger and more protracted downturn than other G10. While inflation has picked up and there are risks that some minority voices within the ECB’s Governing Council will mimic voices from other central banks on normalising policy, we expect the core of the Council to hold firm and keep policy ultra-loose for the foreseeable future," says Barth.

The Euro-Pound exchange rate is forecast by Barclays to trade at 0.84 by year-end, 0.84 by end of March 2022, 0.83 by the end of June and 0.82 by the end of September 2022.

This gives a Pound-to-Euro exchange rate forecast of 1.19, 1.2050 and 1.22 respectively.

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