- The worst-case scenario in the UK economy has been averted
- Shallow & short-lived technical recession implies that its economic outlook is better than Europe's
- BOE can remain less dovish compared to the likes of the ECB & SNB
- BOE rate cuts expected to start later in the year
- GBP may have room to outperform against EUR & CHF
Worst-case scenario in the UK economy is not panning out. Downside expectations not materialising for the GBP. Scope to turn positive on GBP.
- We have held a largely GBP-negative view since last year on the back of a weak macro momentum. This soft growth outlook culminated in the UK economy entering a technical recession in 4Q23, after printing a -0.3% q/q GDP contraction. However, it has also become clear that this technical recession is expected to be shallow and short-lived.
- The UK economy is not falling off the cliff. It more closely resembles a slowdown after the strong growth seen during the pandemic reopening phase, rather than a more classical “recession”. In fact, the worst may actually be over. For one, the UK services PMI (which accounts for a larger part of the economy than manufacturing) has bounced back strongly from its trough in Sep 2023 (49.3), and is now firmly in the expansionary zone at 54.3 in Feb (preliminary) – this suggests that the 1Q24 GDP number may enter at a q/q positive, effectively lifting the UK economy out of a technical recession the very next quarter.
- On the inflation front, the headline CPI is sticky at the 4.0% handle, still among the highest compared to other major economies. Wage growth in 4Q23 was also above 6.0% y/y, a run-rate way higher than what is needed for overall price pressures to return to the Bank of England’s (BOE) target range.
- Thus, both on the growth and inflation counts, the BOE can remain one of the least dovish central banks around. Two members of the MPC are still voting for rate hikes in its Jan decision. The market’s BOE implied pricing are for an Aug rate cut, the latest among the European central banks. Thus, 2Y and 10Y gilt yields have held up better this year compared to bund and Swiss government bond yields, giving the GBP an interest rate differential advantage over the EUR and CHF.
Prospects for the CHF and EUR are more challenging now.
- The CHF outperformed within the G-10 space by a considerable margin in 2023. However, that outperformance is now being reversed, and for good reason. At the start of this year, the CHF is historically at its most expensive level against Switzerland’s major trading partners since 2015. That has impacted certain industries negatively. With the Swiss current and expected inflation now within the central bank’s target range, an explicitly strong CHF is no longer a policy priority. Instead, a softer CHF can help to provide some support for its export-oriented industries. This shift in policy priorities should favour a weaker CHF.
- Indeed, the CHF is one of weakest performing currencies YTD. With an outside chance of the Swiss National Bank (SNB) cutting its policy rate as early as its Mar meeting, we expect the CHF to see further pressure going forward.
- Meanwhile, the Eurozone economy continues to be weighed down by an anaemic Germany. Eurozone manufacturing PMI saw a deepening slowdown to 46.1 in Feb (preliminary). The services sector is healthier, but the services PMI only managed to enter at an even-keel 50.0 after six consecutive months of contraction. Compared to the UK, the Eurozone economy still looks to be in a worse shape.
Taken together, the GBP looks to be in a better position relative to the EUR and GBP. Look for a higher GBP-CHF and lower EUR-GBP going forward.
- The GBP has been resilient amid the USD bounce higher in 2024. The GBP-USD kept within the 1.2600 – 1.2800 range through Jan, and only with a very persistent USD bounce that the range went slightly lower to 1.2500 – 1.2700 in Feb. Dips below the 200-DMA (1.2569) have been brief and well-supported. With the USD’s upside momentum now coming into question, GBP-USD downside may no longer be forthcoming over the tactical horizon. Our preference shifts to being buyers on dips towards 1.2550.
- The GBP may instead find better upside traction against its European counterparts. The GBP-CHF has been in a steep uptrend channel, and most recently is anchored around the 200-DMA (1.1108) (a). It is also looking to climb higher off that key resistance level and the Nov peak (b). In terms of overall momentum, the MACD shows a strong upside (c). Despite the recent strong run-up, the pair is also not yet in an outright overbought situation (d).
Chart 1: GBP-CHF daily chart from Jun 2023
Source: Bloomberg, DBS GFM
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