Pound's problems likely to persist for now

Summary

• The latest report card on U.K. economic activity reveals that growth is still lacking in momentum, while labor market trends have also started to soften. With wage gains still not keeping pace with inflation, we still expect a mild U.K. recession as declining real household incomes weigh on consumer spending.
• However, that recession could be shorter and shallower than previously forecast. The U.K. government announced plans to cap energy prices for households for up to two years, and also provide support to business, which should result in a lower peak in inflation and a smaller contraction in GDP. We now forecast a smaller decline in U.K. GDP of 0.5% in 2023, and a slightly stronger rebound in 2024 of 2.2%.
• Against this backdrop, we remain comfortable with our forecast path of moderate U.K. monetary tightening. We expect the Bank of England to raise its policy rate 50 basis points to 2.25% at next week's monetary policy announcement, and follow up thereafter with a 50 basis point rate increase in November and a 25 basis point increase in December, which would see the Bank of England's policy rate peak at 3.00% by the end of this year.
• With Bank of England tightening set to lag the Fed and fall short of market expectations, we expect renewed downside in the pound. We see the GBP/USD exchange rate falling to $1.1200 or below by late 2022/early 2023. Thereafter, as the U.S. economy also falls into recession and the Fed reaches the end of its tightening cycle we expect some rebound in the pound, to $1.1500 by the end of 2023.

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