3 Reasons For Q1 2023 GBP/USD Losses To 1.12

Bank of America: UK Economic Vulnerability, Risk Aversion and Dollar Revival and will trigger Q1 GBP/USD Losses to 1.12

According to Bank of America, persistent inflation pressures will force central banks to maintain higher interest rates for longer which will undermine risk appetite and strengthen the dollar.

The bank also considers that UK pessimism is justified and forecasts that the Pound to Dollar (GBP/USD) exchange rate will slide to 1.12 at the end of the first quarter.

GBP/USD traded around 1.2175 on Friday as it retreated from 4-week highs at 1.2250.

UK Pessimism Justified, Largest Slide in Disposable Income for 60 Years

Bank of America maintains a negative stance towards the UK economy. Although the political outlook has stabilised and financial stability has been restored, the bank still considers that global sentiment remains negative.

According to BoA; “The UK asset markets have been reassured by the UK Budget and the overall approach of the new UK PM and Chancellor. Nevertheless, investors remain very skeptical toward the UK economy’s prospects and GBP as a result.”

The bank focusses on the hit to consumer spending from a further increase in retail energy prices as well as wider inflation pressures. In this context, it considers that the global lack of confidence in the Pound is justified

BoA adds; “To a large extent, we understand: our economists expect a recession in the UK, forecasting the largest real disposable income drop since at least the mid-1950s.”

BoA is also concerned that overall inflation pressures will sap consumer spending power.

It adds; “while headline inflation has likely peaked, they expect the underlying inflation pressures to persist.”

BoA expects that the Euro to Pound (EUR/GBP) exchange rate will be 0.89 at the end of the first quarter (1.12 for GBP/EUR)

Dollar Set to Regain Ground on Risk Aversion

Although BoA expects that the Pound will remain vulnerable, a key element in the forecast is that t expects the dollar to regain ground.

The bank expects that inflation pressures will be sticky which will force the hawkish central bank stances to be maintained until there is clear evidence that inflation is retreating towards 2%.

It adds; “We would particularly emphasize the strong commitment of central banks to fight high inflation.”

BoA also expects that central bank tightening will increase the recession risk; “Tight monetary policies during a recession is something that markets have not seen since the 1980s and are not currently pricing, in our view (bad news for the economy will be bad news for markets).”

The bank also points to financial stability risks. According to BoA; “All this suggests to us that the market euphoria since mid-October may be overdone.”

Weaker risk appetite would boost the dollar as well as leading to fresh vulnerability for the Euro and Pound.

BoA forecasts indicate that the Euro to Dollar (EUR/USD) exchange rate will slide back to parity at the end of the first quarter.