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The British Pound was the second-worst performer in the G10 FX space over the past 24 hours despite some strong UK economic data releases that led some analysts to maintain a constructive stance on the currency.

The performance serves as a warning that on a seasonal basis, February is a traditionally tough month for the Pound. Justin McQueen, a Reuters market analyst, warns that this seasonal underperformance tends to last until mid-March.

"Positioning is also a headwind with GBP net-longs elevated," says McQueen.

"We're also wary of the pound’s positioning risk given speculative bets on the GBP appreciating are stretched, well above their long-term average," says George Vessey, a currency strategist at Convera.

These headwinds are based on flows and point to tactical and global considerations as being behind the Pound's setback, with the potential for more selling to come in the short term.

The GBP to EUR conversion has dropped below the 1.17 support level amidst the broader GBP setback, reminding us that the exchange rate has struggled to stay above 1.17 for extended periods.

The GBP to USD conversion has declined below 1.26 as the tight trading range of 2024 finally broke in the face of the broader USD surge that followed last Friday's U.S. jobs report and Monday's ISM data.

But a number of analysts we follow tip the Pound to remain an outperformer in the G10 FX space after IHS Global revised higher its UK activity data for January. The services PMI was upgraded to 54.3 from the first estimate of 53.8, while the composite PMI was upgraded to 52.9 from 52.5; confirming the UK economy is firmly in expansion mode at the start of the year.

The ONS meanwhile confirmed the UK's unemployment rate fell to 3.9% in the three months to November from 4.2% in the three months to August.

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The strength of the labour market will come as a surprise to the Bank of England, which has not viewed official unemployment figures since last Autumn owing to statistical difficulties facing the ONS and has instead been relying on less flattering experimental data.

"That suggests a tighter labour market than we or the Bank of England had thought," says George Buckley, an economist at Nomura.

The data should theoretically support UK interest rates and the Pound as it suggests UK domestic inflationary pressures will stay elevated and require interest rates to stay higher for longer.

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Last week's Monetary Policy Report from the Bank of England forecast a 4.3% unemployment rate for Q4, versus the 3.9% confirmed by the ONS.

"At the margin this is helpful to the cause that the MPC will keep rates on hold for longer – particularly with the tightness of the labour market still a key input into the Bank’s decision making – as was confirmed in last week’s decision," says Buckley.

Foreign exchange strategists at Barclays say if the Bank of England sticks to its 'higher for longer' policy, the Pound can remain supported.

"Governor Bailey was careful not to fuel expectations for imminent rate cuts. In all, the pound is unlikely to lose its carry attractiveness any time soon, which coupled with continued demand outperformance, leaves us constructive on its outlook," says Barclays.

Above: GBP/EUR has fallen back below 1.17, but retains a constructive setup.

The ONS suspended the Labour Force Survey (LFS) survey in October because of falling response rates, which led to a biased sample as older people responded more to the phone surveys and younger people did not.

The new data comes after the ONS statistically corrected for the sample bias due to the low response rates and made re-weighting adjustments to account for population changes.

With the unemployment rate running at levels lower than the Bank of England expected, the prospect of wages staying elevated grows. This can contribute to domestic inflationary pressures and pressure the Bank to keep interest rates higher for longer.

If the Bank cuts after the U.S. Federal Reserve and Bank of England, the Pound can stay supported.

Barclays is particularly constructive on the Pound's prospects against the EUR and CHF, "where the macro backdrop is more challenging".

Above: GBP/USD has sustained significant technical damage over the past two days.

Andrew Goodwin, Chief UK Economist at Oxford Economics says concerns about the enduring strength of pay growth will lead the MPC to err on the side of caution when it comes to the timing of the first cut.

"So while May remains a possibility, we now lean towards June being the more likely option," says Goodwin.

The Bank of England last week said inflation would fall to the 2.0% target as soon as April but would then rise again, potentially hitting 3.0% by year-end.

This speaks to a 'stickier for longer' inflation profile that would be met with interest rates falling more slowly than markets were anticipating at the start of 2024.

The Pound has rebounded over the early stages of the year as markets anticipate less by way of cuts.

Before the current setback, the Pound to Euro exchange rate rose for six weeks in succession. The downside will likely be limited if the market bets the Bank of England will only cut interest rates after the Fed does.

"We also think uncertainty around wages and the potential inflationary impact of Red Sea disruption will influence the pace of cuts. We now forecast there will be 75bps worth of rate cuts this year (previously 100bps), with subsequent cuts coming at the August and November meetings," says Goodwin.