Pound Sterling sets to report almost 5.50% gains in 2023 amid cheerful market mood

Pound Sterling recovers swiftly as investors’ risk-appetite revives.
Deepening UK recession fears could dent the Pound Sterling’s outlook.
Persistent Fed rate-cut bets may continue to weigh on the US Dollar.

The Pound Sterling (GBP) is set to end 2023 with decent gains of almost 5.60%. The rally in the Pound Sterling is backed by consistently surging risk-appetite of the market participants due to easing fears of a global recession. Western central banks will likely wind-up their historically faster rate-tightening campaign amid easing price pressures, which has improved appeal for risk-sensitive assets.

The performance of the Pound Sterling against the US Dollar has remained better as the Bank of England (BoE) may be laggard in reducing borrowing rates among central banks from Group of Seven economies. Economic conditions for BoE policymakers are worsening again as the United Kingdom economy has been exposed to a technical recession due to a vulnerable demand environment. The BoE could begin cutting interest rates earlier to avoid fears of any economic shrinkage, which may dampen the Pound Sterling outlook significantly.

Daily Digest Market Movers: Pound Sterling drops as US Dollar recovers

Pound Sterling falls as the risk-appetite of the market participates eases amid thin trading actiovity.
The broader demand for the Pound Sterling is upbeat amid hopes that there won’t be global recession as price pressures have eased significantly
The appeal for risk-perceived assets is bullish as investors lean towards expectations of early rate cuts by the Federal Reserve.
The Fed is expected to start lowering borrowing costs from March as price pressures in the United States economy are clearly in a downtrend.
Action in the FX domain is expected to remain muted in the last trading session of 2023 but next week firecrackers are likely amid the release of the S&P Global PMI for the manufacturing and service sector.
The Pound Sterling recovers as investors expect interest rate cuts from the Bank of England (BoE) to be delayed compared to the Fed and other central banks from the Group of Seven economies.
The United Kingdom’s high inflation rate is the reason for expecting rate cuts to come later there than the other G7 nations.
UK’s core inflation is slightly above 5% and policymakers lack confidence in achieving price stability in a timely manner due to robust wage growth.
Market participants are already pricing in a decline in Fed-BoE policy divergence, which is likely from March 2024.
Higher demand for the Pound Sterling against the US Dollar could fade as conditions of a technical recession in the UK economy are strengthening, which could force the BoE to announce rate cuts earlier-than-anticipated.
Revised estimates from the UK Office for National Statistics (ONS) have indicated that the economy contracted by 0.1% in the third quarter of 2023.
The BoE is not expecting growth in the final quarter of 2023, which indicates a technical recession is highly likely.
A recession situation may force the BoE to start unwinding its restrictive monetary policy stance.
Meanwhile, the recovery in the US Dollar Index (DXY) has stalled amid persistent Fed’s rate cut bets. The USD Index has rebounded to near 101.40 but could fall back towards five-month low near 100.60.
The USD Index has been facing an intense sell-off from last two months as a higher for longer interest-rate stance from Fed policymakers has given way to expectations of rate cuts, as the central bank tries to avoid the consequences of over-tightening.
Next week, investors will focus on the ISM Manufacturing PMI and the Employment data for December, which will provide guidance for further action by the Fed in its first monetary policy meeting of 2024 on January 31.

Technical Analysis: Pound Sterling struggles to sustain above 1.2700

Pound Sterling struggles for a meaningful recovery in the Lonson session after correcting on Thursday as the risk-appetite of the market participants has surged again. The GBP/USD pair is aiming to recapture its five-month high of 1.2870. A rally in the Cable may continue as the 20 and 50-day Exponential Moving Averages (EMAs) are advancing. Momentum oscillators indicate sheer strength in the upside move.

BoE FAQs

What does the Bank of England do and how does it impact the Pound?

The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).

How does the Bank of England’s monetary policy influence Sterling?

When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.

What is Quantitative Easing (QE) and how does it affect the Pound?

In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.

What is Quantitative tightening (QT) and how does it affect the Pound Sterling?

Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.

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