GBP/EUR to Rise Despite Carney's Demolition Job say E&Y
Pound sterling is to weaken further against the US dollar but recover lost ground against the euro it is suggested by a leading economic forecaster.
Ernst & Young have released their first set of economic and financial forecasts of 2016.
The forecasts were released before Tuesday the 19th's demolition job of the pound by the Bank of England's Mark Carney who suggested the UK is still a long way away from an interest rate rise.
This seems to have caught many by surprise; the pound to euro exchange rate has slumped below the key 1.30 mark while against the U.S dollar sterling is below 1.42 at the time of writing.
But, in their early-2016 forecasts Ernst & Young seemingly saw such an announcement by the Bank of England as inevitable.
“The economy’s slowdown in both real and nominal terms is another reason to expect a further period of unchanged interest rates. Downward revisions to recent GDP growth estimates mean that the economy remains a long way from one of the Governor’s criteria for considering a rate hike – sustained growth of above 0.6% per quarter,” say Ernst & Young ITEM Club in their Winter Forecast publication.
Consequently, economists do not expect the first post-crisis hike in Bank Rate until the last quarter of 2016, with the risks, both domestic and global, suggesting that an even more prolonged period of record low rates is not out of the question.
The Bank of England’s MPC have warned that subsequent rises in interest rates are set to be slow and gradual.
“As such, we expect Bank Rate to only reach 1% by the middle of 2017 and end next year at 1.5%,” say Ernst & Young.
The recent mood music of the MPC has been firmly dovish.
For example, having signalled in 2015 that he expected to be considering raising interest rates around the turn of this year, Mark Carney told the Financial Times in an interview that the timetable is likely to slip because cost pressures have increased more slowly than anticipated.
On Monday the 18th we heard from MPC member Gertjan Vlieghe that he will not be rushed into voting for an interest rate rise based on a number of key observations.
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Wages and Inflation to Remain Muted
Of note in the latest Winter Forecasts are the expectations for UK inflation and pay rises to remain subdued.
Indeed this was borne out by recent jobs data for December, which, although showing unemployment falling to 5.1%, nevertheless showed wages slowing down the pace at which they rise.
Ernst & Young expect a steady recovery in earnings growth but this should be offset in part by an improvement in productivity.
Therefore the degree of spare capacity in the economy is unlikely to diminish quickly, preventing firms from doing much to improve their profit margins.
The Bank of England have always said that one of the key considerations ahead of an interest rate rise will be that spare capacity in the economy has come down.
Therefore, CPI inflation is forecast to average just 0.7% in 2016, requiring Mark Carney to write a further series of explanatory letters to the Chancellor.
And beyond that inflation is likely to remain below the 2% target for a prolonged period, averaging 1.6% in 2017n and 1.8% in 2018.
Pound Sterling: Recovery v Euro, Downside v Dollar
Sterling has weakened of late following the US Fed’s decision to raise rates and a less dovish than expected statement from the ECB.
The GBP to EUR conversion has been in decline for the past 8 weeks with a fall from levels above 1.40 at the start of December to the current testing of 1.30.
The GBP to USD conversion has meanwhile been trending lower since mid-2014 in line with the longer-term cyclical upturn in the US dollar complex.
How then do Ernst & Young expect the British pound to perform in this period of Bank of England inaction?
“With the MPC unlikely to follow the Fed’s action for some time, sterling looks likely to weaken further against the dollar, but with the ECB continuing to loosen policy via QE, sterling should recover a little ground against the common currency,” say economists.
The recovery by sterling against the euro would fall in line with the views held by other institutional analysts we follow.
The average forecast held by the 16 leading global investment banks we poll for the pound to euro, over the 3-6 month horizon, sits at 1.4493.
That said, it is important to note that analysts are quickly changing tone and downgrading their forecasts made for 2016.
The average forecast for 9 months is at 1.42.
In short, the leading lights in global forecasting continue to hold out for a stronger GBPEUR. Unfortunately, at this stage in time it looks as though many have been caught wrong-footed.
