J. Safra Sarasin update GBP forecastsJP Morgan maintains strategic 'shorts' on GBPUK housing downturn sends a warning signalOf impending H2 economic slowdown

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A number of foreign exchange analysts we follow have over recent hours revealed research that shows the British Pound is set for a period of weakness as the UK economy enters a slowdown in the second half of the year, led by the housing market.

Foreign exchange strategists at JP Morgan are sellers of the Pound, saying it is only a matter of time before a more protracted pullback plays out in response to deteriorating economic growth fundamentals.

"The lack of GBP appreciation on the back of the shockingly high inflation print in the UK signalled that the sterling reaction function may be shifting given the growth implications," says Patrick R Locke, strategist at JP Morgan.

The call comes following a period of outperformance in the Pound to Euro and Pound to Dollar exchange rate pairs (in fact, GBP has outperformed all other majors in 2023), linked to better-than-expected economic data and the Bank of England's commitment to higher interest rates.

But Locke notes UK housing metrics are continuing to deteriorate, which comes against a backdrop of very high and sticky inflation.

"After some improvement in the first few months of the year, mortgage approvals fell below expectations again, signalling that financial conditions are beginning to bite the consumer," he says.

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Nationwide last week reported a 0.1% month-on-month fall in house prices in May as the April rebound of 0.4% m/m fizzled out.

The year-on-year decline in house prices stood at 3.4% in May, the sharpest decline recorded since the financial crisis of 2009.

"House prices flattened off in May after a rise in April. But with mortgage rates now on their way back up we suspect that the stabilisation in prices over the last couple of months will soon give way to renewed falls," says Andrew Wishart, Senior Property Economist at Capital Economics.

JP Morgan's analysts say any further tightening from the Bank of England only puts more pressure on the housing market and thus the consumer, especially as fixed-rate mortgages reset later this year.

Markets currently favour at least a further 75 basis points of rate hikes to come from the Bank in 2023.

Image courtesy of Berenberg.

To be sure, there are a number of analysts who say the Bank of England's stance is supportive of the British Pound's outlook, particularly in a world where foreign exchange markets are being led by interest rates.

But for some economists, the Pound's reaction function to higher interest rates risks flipping to negative if the economy slows.

"Repeated growth downgrades should thus reverse sterling’s gains this year which were driven to a large extent by growth improvements," says Locke.

Claudio Wewel, FX Strategist at J. Safra Sarasin, the Swiss private bank, agrees:

"While Pound Sterling is likely past peak pessimism, we do not think that sterling's recent recovery will extend. According to our projections, the UK economy will contract in 4Q23 and in the first half of 2024."

Wewel says renewed austerity drive should add to this, "hence we remain cautious on sterling".

J. Safra Sarasin's latest forecasts show the Pound will likely come under pressure near and medium term, but longer term a more sustained recovery is likely:

"Short term: GBPUSD risk reversals have rebounded, yet they remain bearish, along with net speculative positioning. Furthermore, the pound should remain vulnerable to risk-off moves.

Medium term: Weak UK growth on the back of cost of living squeeze should weigh on sterling.

Long term: Sterling should recover once the global cycle re-accelerates, yet the UK’s external imbalances are set to remain an issue."

"We expect a rebound in sterling once the global cycle re-accelerates," says Wewel.

EUR/GBP is forecast by J. Safra Sarasin to ease higher to 0.87 by the end of September, a level J. Safra Sarasin expects to be held through the remainder of the year and 2024.

This gives a GBP/EUR exchange rate forecast profile of 1.15.

GBP/USD is meanwhile forecast by the Swiss private bank to ease back to 1.22 by end-September, 1.21 by year-end before recovering through 2024 to 1.26.