A budding economic recovery and a later start to the Bank of England’s interest rate cuts will support sterling over the coming weeks, analysts predict.
On Monday sterling was trading around 0.2 per cent higher against the dollar at $1.269. Although the pound is down against the dollar this year, analysts think it will pick up again as growth picks up.
Although the UK saw a shallow recession in the second half of last year, private sector output rose to its highest level in nine months in February, surprising economists who had expected a slight fall in activity.
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Recession ‘already over’ as economic activity picks up again but inflationary pressures grow
A number of economists said the figures suggested that the UK’s shallow recession was “already over.”
Bank officials meanwhile have stressed that inflation remains too high to justify an imminent easing in monetary policy.
Inflation remains more than double the Bank’s two per cent target, while wage growth and services inflation – both of which measure domestic price pressures more accurately – are above six per cent. This will likely force the Bank to wait until at least the summer to start cutting rates.
In a note to clients, analysts at Barclays wrote: “February’s PMIs provided more evidence of demand resilience, both in absolute terms and relative to the eurozone, while BOE speakers seemed in no rush to start the cutting cycle.”
“Accordingly, we maintain a constructive view of the pound (particularly vs EUR and CHF), which benefits further from the gradual erosion of the Brexit premium ahead of the general election,” they continued.
Paul Robson, head of G10 FX strategy at NatWest, agreed that rate cuts would likely support the pound. “With the Bank of England still waiting for more evidence that inflation is heading back to target, it seems unlikely that the central bank will be in the first wave of central bank cutters.”
Higher rate expectations tend to boost currencies.
However, analysts at JP Morgan were less convinced by sterling’s prospects. “Last week’s Q4 GDP print was a bit of a reality check that the economy was in a technical recession in the second half of last year,” they wrote.
“Despite this week’s strong flash PMI, it’s hard to argue that booming growth is driving FX outperformance,” the analysts continued.
Weaker growth would force the bank to cut interest rates more aggressively than markets think, putting sterling under pressure.