GBP/USD about to probe 2022 lowsGBP/EUR set for third weekly declineAs UK economy set for declineAs per latest retail, consumer confidence data

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The British Pound appears to be entering a phase of capitulation against the Dollar and this is feeding into weak price action against other major currencies, including the Euro.

The Pound was down by three-quarters of a percent against the Dollar on Friday following the release of a set of poor UK data covering the retail and consumer sector that suggests the coming months will be dire for the UK economy.

Although UK retail sales volumes rose by 0.3% in July 2022 following a fall of 0.2% in June 2022, they were down 3.4% on the year and all signs point to further deceleration as inflation surges.

The inflation shock meanwhile looks to have no end as energy prices in Europe and the UK continued a relentless climb higher on Friday.

Rupert Harrison, a portfolio manager at BlackRock, says UK and European gas and power prices continue rising to "truly scary levels".

"The Government will have to act on a very large scale to support households, especially those on lower incomes - and also probably small businesses," he says, adding:

"The scale of this shock is hard to overstate."

GfK's measure of UK consumer confidence fell to an all-time low according to a release out Friday, confirming a bleak winter awaits the UK economy.

GfK said, "the crisis of confidence will only worsen with the darkening days of autumn and the colder months of winter".

Above: The Pound is under the hammer against the Dollar (top) and now the Euro (bottom).

The Pound to Dollar exchange rate fell to 1.1838 in the hours following the release and all eyes are now on the 2022 low at 1.1760, which will surely be probed soon.

Those looking to make payments will see rates quoted at around 1.1596 on their bank accounts and 1.1798 at independent payment providers, according to our data.

The Pound to Euro exchange rate was also in sell-off mode, going to 1.1770, as it prepared to register a third consecutive weekly decline. Our data shows bank accounts will be offering in the region of 1.1535 for euro payments while independent providers are offering around 1.1735.

"GBP downside risks persist," says Derek Halpenny, Head of Research for Global Markets EMEA at MUFG.

"The GBP/USD rate has broken back below the 1.2000 level and a recent build-up of long GBP positioning by Leveraged Funds could be vulnerable to liquidation propelling GBP/USD lower still," he adds.

The narrative concerning the UK economic outlook is resolutely bleak and this will be fuelling perceptions towards the UK currency.

Although regions such as the Eurozone are facing an equally dire situation, a 'perma bear' approach to then UK held by the analyst community and financial commentariat since the Brexit referendum will ensure the Pound remains the poster child of the stagflation trade.

"Evidence of very depressed confidence contrasted with a surprise rise in retail sales in July. Volumes grew 0.3% m/m, only the second monthly increase in the year-to-date. However, July's growth was more than accounted for by a jump in online sales, aided by promotional activity, while a breakdown of the data suggested cost-of-living pressures at work," says Andrew Goodwin, Chief UK Economist at Oxford Economics.

UK inflation is forecast to peak near 13% said the Bank of England earlier in the month, while economists at Citi say a rate of 15% is more likely.

This has heaped pressure on UK workers who are now increasingly prone to strike for better pay conditions.

"Strike action across the rail and bus networks this week and going forward will also weigh on economic activity with the unions warning of 'indefinite' strike action. So we doubt the retail sales data will change the dial on investors’ expectations of the outlook for the UK economy and see this break lower in GBP/USD extending further to the downside over the coming weeks," says Halpenny.

The Bank of England will meanwhile have little choice but to continue raising interest rates as inflationary pressures continue to build.

But in doing so they add to the headwinds facing the economy and a policy of higher interest rates will inevitably contribute to a recession they expect to start towards the end of this year.

Money market pricing now suggests investors are expecting the Bank to 'out hike' most developed central banks in this cycle, including the Fed.

Above: The market has ramped up its expectations for the amount of hikes to come out of the Bank of England. Image courtesy of Goldman Sachs.

Typically this would offer an interest rate advantage for the Pound as foreign investors seek out the higher yields offered in the UK.

But the market is clearly not buying this narrative instead opting to sell the Pound.

This is because they see the Bank as a 'reluctant hiker', i.e. one that is always chasing the market's expectations and never guiding the market.

In a recent research note HSBC said the market is tired of waiting for the Bank of England to turn 'hawkish', saying the central bank was one reason to bet against the Pound.

Furthermore, money market pricing also sees the Bank cutting interest rates in 2022, potentially more than other central banks, and it is these cuts that forward-looking markets are potentially focussed on.

"Investors continue to anticipate a quick turnaround in policy from rate hikes to rate cuts," says Kieran Tompkins, Associate Economist at Capital Economics.

"We think the Bank of England will hike interest rates by less than money markets now discount, which in turn should keep the pound under pressure," he adds.

Capital Economics anticipates the Pound will remain under pressure during the remainder of 2022 as a consequence of recent developments and market dynamics that includes an unwillingness to respond to rising yields.

The market expected at least three further 50 basis point hikes from the Bank of England over the remainder of 2022.

The implications of these expectations for Pound Sterling are significant: if it meets this target the currency would likely remain supported, but another 'dovish' pivot from the Bank that disappoints against expectations could send it lower.

"We suspect that investors have probably got a bit ahead of themselves by expecting the Bank of England to raise rates to close to 4.0% and, ultimately, will have to pare back those expectations," says Tompkins.

Capital Economics forecasts the Pound-Dollar exchange rate will edge lower to 1.18, with risks to the downside.