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The British Pound is predicted to come under pressure against the Euro and Dollar ahead over coming weeks and months, with a more sustained recovery only likely in the second half of 2022.
This is the expectation of Barclays, who have updated clients with their exchange rate forecasts for the upcoming year.
The findings are largely bearish on Sterling but a key takeaway of the research is that the Dollar's bull run that characterised much of 2021 will fade and allow some recovery in GBP/USD.
And it appears that the Euro will recovery much of its 2021 losses against the Greenback over 2021, although the Pound's H2-2022 recovery means the GBP/EUR exchange rate ends next year around the levels we currently find it.
For the Pound, the Bank of England's race to raise interest rates is not going to offer any support with Barclays arguing that nominal interest rate expectations matter little for the currency.
This is important: expectations for higher rates at the Bank of England show up primarily in nominal interest rates.
But real interest rates account for inflation and therefore tend to be lower than their nominal counterparts.
Therefore, high inflation = low real interest rates.
"GBP's close correlation to real, not nominal, interest rates explains its past despondence to elevated rates market expectations for front-loaded Bank of England tightening," says Eimear Daly, analyst at Barclays.
Daly says rising UK inflation is undercutting the positive impact of rising Bank of England rate hike expectations.
Markets currently anticipate a first rate hike in December or February, followed by further hikes in 2022 that takes Bank Rate to 1.0% by year-end.
"However, rising inflation into Q1 22 should undercut real rate support for the pound," says Daly.
Above: GBP performance in 2021.
- Reference rates at publication:
GBP/EUR: 1.1887 \ GBP/USD: 1.3385
- High street bank rates (indicative): 1.1654 \ 1.3110
- Payment specialist rates (indicative: 1.1830 \ 1.3320
- Find out about specialist rates, here
- Or, set up an exchange rate alert, here
Barclays says slowing economic growth and ongoing concerns about the EU-UK post-Brexit trading relationships will limit the ability for Sterling to rally near term.
But, further out, "elevated levels of foreign acquisition and investment in UK assets should provide an undercurrent of support for GBP".
This expectation explains the Pound's in the second half of 2022 in the below exchange rate forecasts.
For the Euro, interest rate expectations will matter too.
But unlike the UK, the Eurozone is expected see lower inflation levels and this makes for rising real yields.
Barclays' forecasts are for Eurozone inflation to peak in the fourth quarter of 2021 and quickly fall back below target by end-2022.
This "means the shift in real rates will be in the EUR’s favour in the year ahead," says Daly.
In contrast, their base case is for U.S. CPI inflation to peak at a higher level and remain elevated throughout 2022.
"This should undercut US real rates given our base case assumption that the Fed will not hike rates until Q2 23," says Daly.
Barclays also see greater room for the rates market to price in ECB tightening in the near term with only 20bp of ECB hikes priced in by end-2022 compared to 80bp for the Fed.
Above: EUR performance in 2021.
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This expectation will have gained traction on November 23 when two members of the European Central Bank's Executive Board signalled the potential for a more 'hawkish' shift in policy.
Isabel Schnabel, a Member of the Executive Board of the ECB said "the risks to inflation are skewed to the upside" and she joined a fellow board member in playing down the negative impact of renewed Covid restrictions in the Eurozone.
Klaas Knot who said in an interview that ECB interest rates will likely rise after 2022.
This is important as it opens the door to a 2023 rate hike, contrasting to the ECB's favoured guidance for a rate hike in 2024.
Knot also played down the impact of renewed Covid restrictions in countries such as Austria and the Netherlands.
Daly says increasing German political opposition to the ECB’s accommodative policies should supports a hawkish shift.
The risks around the French presidential election are meanwhile described as "well priced".
The rump of the year-ahead forecasts coming in from investment banks suggests the Dollar will continue to shine in 2022.
But Aroop Chatterjee, Head of FX & EM Macro Strategy Research at Barclays, says to expect modest U.S. Dollar depreciation over the coming year.
This reflects a view of a positive backdrop for risk and commodities alongside moderate U.S. Dollar overvaluation.
"Upside risks are largely from risk-off moves rather than US outperformance and limited relative to downside risks stemming from aggressive market pricing for tighter Fed policy," says Chatterjee.
The analyst sees upside risks to their Dollar forecasts coming from a "muddled" debt ceiling resolution and/or risks of central banks overtightening in response to inflation and curbing growth prematurely.
"More persistence in ongoing disruptions such as the China slowdown, supply bottlenecks, and the energy crunch, could also be supportive of safe haven dollar demand," says Chatterjee.
Exchange Rate Forecasts for 2022
Pound to Dollar: 1.33 (end of Q1, 2022), 1.37 (end of Q2, 2022), 1.40 (end of Q3, 2022), 1.42 (end of Q4, 2022).
Euro to Dollar: 1.16, 1.18, 1.19, 1.19.
Euro to Pound: 0.87, 0.86, 0.85, 0.84.
Pound to Euro: 1.15, 1.16, 1.18, 1.19.