Will the British pound show us a surprise in 2023? As September's events with the record decline in the exchange rate showed, anything is possible. However, market players are now hoping for an equally magical recovery. Analysts at investment banks, including Morgan Stanley, which seeks to reveal the top 10 surprises for 2023, are divided.
"Given that every year brings surprises, we've laid out 10 things that would make investors think differently and move global macro markets," the banking strategists wrote.
What to expect from the pound in the new year, will the forecasts come true?
For now, the pound is a currency that falls behind in 2022. It has lost ground against the dollar and euro, as well as against commodity dollars and the Swiss franc. Ahead of the new year, Morgan Stanley economists share the consensus that a challenging 2023 year awaits the UK economy.
Growth in Great Britain could be the worst among the Big 10 and even among emerging markets. For that reason, the bar is set incredibly low for unexpected growth that would defy consensus and offer sterling a favorable domestic story.
The bearish outlook is now supported by many, even despite the pound's impressive rally against the dollar in recent weeks. The British currency needs a major breakthrough in order to regain its appeal. And the recent rally was largely due to a combination of adjusting positions and a broad weakening of the dollar. The fundamental views on the pound remain the same.
Pound. Important details.
The driving force behind the expectations of an economic downturn are expectations of an ongoing energy crisis, which will curb growth and keep inflation at a high level. That said, a significant drop in energy prices will be a key positive factor for the UK and the pound. Higher inflation is largely related to the energy sector.
There are signs of some improvement in this area. If you look at UK gas prices one month ahead, that is, with delivery in January, the contract is at its lowest level since mid-June.
Why the comparison with June? Because this is the month in which gas prices in Europe and the U.K. rose at an extraordinary pace. In fact, fuel prices are approaching the levels seen before the February events.
Another problem is the shortage of workers in Britain. Vacancy rates remain high in the country, as businesses cannot find the staff they need, which means that production suffers.
The reasons for the labor shortage are complex, and it is unlikely to be solved quickly. Even record levels of immigration in the UK can't save the situation.
The post-Brexit labor market has changed at a structural level and in a more unfavorable direction.
If the British government finds a solution and the labor market begins to recover from recent shocks, the pound could win, according to Morgan Stanley.
Another potential stimulus for sterling could be a more resilient consumer, either through the use of excess savings or through a new surge in wage growth. For now, the Brits continue to build up their savings.
"Although we don't expect this to happen, especially given that the high cost of living reduces purchasing power, consumers using fuel savings can become a potential factor for more sustainable growth in 2023," analysts admit.
The pound could have a bullish surprise, but not immediately. The UK, like the pound, is likely to be unlucky in the coming months.
Economists at Morgan Stanley forecast GBP/USD at 1.1300 by the end of the first quarter of 2023, 1.1400 by the end of June, 1.1500 by the end of September and 1.1600 by the end of the year.
Federal Reserve and Bank of England policies
Both central banks are likely to remain hawkish, with the British central bank still lagging behind the U.S. and unlikely to catch up.
The Fed is setting the markets up for slower economic growth, rejecting the risks of a recession. High rates will remain in place for a longer period of time. The market is currently laying less than 15% that the Fed's target rate will be above 4.75% at the end of December 2023. This uncertainty could set the stage for a bearish trend reversal on the dollar.
If the bond market continues to fight the hawkish Fed and pushes yields lower, the dollar will fall, at least for a while. However, this is not a trend reversal.
Investors' belief in the decline in the yield of treasuries is partly explained by the growing risks of a recession in the United States. Meanwhile, a slowdown in global growth will negatively affect risky assets, which will inevitably lead to a dollar rally.
Thus the GBP/USD bounce in late 2022 could lose momentum in early 2023. The contrast between the Fed and BoE policies will also contribute to this.
Recall that at the last meeting, the British central bank leaned more toward a dovish tone. Politicians' voices were split into three camps. At the same time, the central bank predicted a long period of recession in the country. Inflation is expected to remain high until the middle of next year. Both factors will limit optimism about the pound.
Technical picture of the pound
The pound's momentum weakened above 1.2320, its retreat from the 6-month high at 1.2440 occurred after the key technical indicators gave a signal for a bearish reversal.
If bears remain active, a corrective decline may test the 1.1850 area. The next target is 1.1260. Further, with the pronounced weakness of the bulls, a stronger sell-off of the pound is likely up to the 1.0920 mark.
However, bulls may not give in to bearish signals, and then the pair will have a chance to rebound to 1.2700. The return of this barrier is crucial in supporting any attempts at recovery. Next is the 1.2900 mark, but it will be a tough nut for the bulls.
Overall, the GBP/USD pair could be a bearish instrument in the new year. Traders will resort to the strategy of selling on bounces whenever growth resumes.
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