Sterling is the best performing G10 currency this year

LONDON – The: British pound The G-10 (Group of Ten) is the best performing currency in 2023, and some strategists believe that the pound’s rise could continue in the medium term.

Sterling is up more than 3% dollar It hit a 10-month high since the start of the year on Wednesday, driven largely by better-than-expected economic data and a weaker dollar.

The pound was roughly unchanged against the dollar on Thursday morning at $1.2455 by 11:30 a.m. London time. The currency has rebounded impressively from record lows in September following former prime minister Liz Truss’ disastrous “mini-budget”.

Deutsche Bank observed that the market is extremely shorted in 2023 given the extremely gloomy sentiment fueled by gloomy economic forecasts from the IMF, the Bank of England and the UK’s Office for Budget Responsibility, all of which predicted protracted recessions.

The British economy has so far avoided recession and posted stronger-than-expected growth in January. Forecasts for major economic forecasts have now improved, with the OBR no longer predicting a technical recession, defined as two consecutive quarters of negative growth, in 2023.

The country’s fiscal position has improved dramatically, largely due to the sharp fall in gas prices, and further fiscal support from the government has contributed to the growing positivity.

However, the picture is not entirely rosy yet. The UK remains the only major G-7 economy not to have recovered its output to pre-Covid levels and inflation is still in double digits. British households continue to struggle with high food and energy bills, while workers in a number of sectors have gone on mass strike action in recent months amid disputes over conditions and pay.

The Bank of England raised interest rates by 25 basis points to the highest level since 2008 as policymakers grapple with persistently high inflation. The market is about 63% likely to head into the Bank’s May meeting on a quarterly basis.

Risks have ‘shifted to the upside’

Deutsche Bank called it that at the beginning of the year cable would hit $1.25 as that forecast was almost met, FX strategist Shreyas Gopal suggested in a note on Wednesday that “much of the good news from the UK is now probably priced in.”

“The market has converged on our view that UK growth expectations may improve, in line with other major economies for this year, although our home view is still more optimistic than the new consensus,” Gopal said.

“On the micro front, the currency has looked a bit overextended in the last month compared to the performance of relative interest rates, with the added incentive that the market is still largely pricing in another BoE hike at the May meeting, but our main business is set; keep it.”

However, real interest rate differentials could drive cable upside in the medium term, as it has been “displaced and extremely cheap” for almost a year now, Gopal suggested.

“Last year this spread was 100bps worse for GBP, but Cable was around 1.30 and with the rest of the premium coming more into the USD equation, the pound is well placed among the relative winners. dollar decline if private sector leverage is the key differentiator over the rest of the cycle,” Gopal said.

A reduction in external vulnerability, signaled by improved current account data, driven by both lower gas prices and the UK’s focus on foreign direct investment in the energy sector, could also be supportive, Gopal said.

“Overall, domestic good news may now be priced in, but given the external backdrop, risks to our cable outlook are still skewed to the upside,” he added. Deutsche advises investors to go long the pound against both the US dollar and the Swedish krona.

The strongest of the weak

After soaring from late 2020 to late 2022, the traditional safe haven of the US dollar has weakened significantly, with the DXY US dollar currency index down more than 9% over the past six months.

National Australia Bank’s head of FX strategy, Fixed Income, Currencies and Commodities, Ray Attrill told CNBC’s “Street Signs Asia” on Wednesday that the dollar was “incredibly overvalued” and that the Japanese yen and British pound were the most. “underrated”.

As such, he suggested that while much of the recent good news has been factored into sterling’s recent jump from $1.19 to $1.25 in the short term, the two currencies are well-positioned to take advantage of the dollar’s “correction” in the medium term.

“If you look at it from a longer-term purchasing power parity argument or similar real exchange rate arguments, sterling and the yen are particularly weak currencies here. So on that basis if the US dollar continues. to go south, then they’ll probably be the two, in terms of the G-10, that probably have the most potential here,” Atrile said.

The grounds are not sufficient for “firm belief”.

Not everyone is so convinced. Valentin Marinov, head of G10 FX research at Credit Agricole CIB, told CNBC on Thursday that while the data is surprisingly resilient, the outlook for the UK economy is “still not very good even in relative terms”.

“It’s certainly helped by the fact that other economies like the US have seen their outlook deteriorate quite quickly, so that helps the pound, but I wouldn’t think there’s a strong conviction to buy the pound purely on domestic fundamentals. Marinov said.

He also pointed out that historically sterling has been the worst performer of the major currencies in the early stages of the recession since 1980, so when global growth concerns persist as central banks continue to raise interest rates, the pound may not be the safest. bet right now.

“Certainly a remarkable performance at current levels, which is against our expectations, but I would not expect this to extend to a sustained upward trend from here, I would prefer to sell cable here,” he said.

“Eurosterling looks a bit more fairly priced but, again, it’s really about how much the outlook for continental Europe can deteriorate to sort of get back to the low bar that the UK case still is.”