Sterling set to underperform again next year, says Goldman Sachs

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  • Sterling embarks on a bumpy road to 2023
  • Energy prices and inflation drive underperformance
  • But rebound against USD and EUR possible by the end of the year

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The pound has rallied after steep losses earlier so far in the last quarter, but is likely to remain one of the major underperformers in the major currency complex well into the new year, according to the latest forecast from Goldman Sachs.

The pound rose against just four of the 19 G20 peers for the year on Tuesday and posted double-digit percentage losses against the same number, including the Russian ruble, Mexican peso, Brazilian real and US dollar .

However, declines against the Swiss Franc and Canadian Dollar were also in high single digit percentages, while there were only two currencies against which the British Pound managed to make notable gains, including the Japanese yen and Turkish lira.

All this despite a sharp rebound from record lows reached in late September when financial markets protested the government’s past fiscal policies.

“Thursday’s budget was the latest step in a huge shift in fiscal policy, which has significantly reduced the risk premium on UK assets. But we still expect the pound to underperform in the near term as it absorbs the latest negative supply shock in energy prices,” says Michael Cahill, G10 FX strategist at Goldman Sachs.


Above: Sterling’s performance in 2022 against G10 and G20 currencies. Source: British Pound Live.


At the heart of this year’s heavy losses for the pound sterling is the tripling of wholesale prices of mainly imported energy goods resulting from British and European attempts to move away from Russian oil and gas imports without other alternatives or sufficient investment in their development.

This and the rising cost of manufactured goods is a big reason why UK import prices have risen much faster and more than the price of exports, leading to the overall goods trade deficit widening all the time. throughout the year while leading to a negative deterioration in the “terms of trade”.

“The UK is facing a severe energy terms-of-trade shock, but Brexit-related frictions are also weighing on the trade balance (Exhibit 16) and contributing to a very tight labor market,” write Cahill and his colleagues. colleagues in a recent year for the outlook for the pound.

“The UK is the only G10 economy where activity remains below its pre-pandemic level, and our economists expect negative growth in 2023, while core inflation is exceptionally low. strong and shows limited signs of decline,” they added.

It’s not just rising import costs that have weighed on the pound, as the UK has seen one of the biggest increases in inflation among G10 economies as a result of these changes. price and this drove the actual or inflation-adjusted returns. offered UK government bonds well below zero.


Source: Goldman Sachs Global Investment Research. Click on the image for a closer inspection.


Another reason inflation-adjusted yields have fallen so far is a Bank of England (BoE) discount rate that has not kept pace with rising inflation and this has been a major gripe for the many analysts who have held bearish views. on the pound this year.

“Thanks to this shock, the Bank of England has forecast aggressive cuts in inflation (despite upward revisions to short-term forecasts) and insufficient hikes as it finds an increasingly delicate balance between the supporting economic activity and taking steps to resist higher inflation,” he added. Cahill and his colleagues say.

The energy supply shock is unlikely to dissipate anytime soon and it remains to be seen how quickly inflation rates in the UK will return to the Bank of England’s 2% target. hence why the Goldman Sachs team predicts another year of underperformance for the British pound against many currencies. .

Against the US dollar and the euro, however, the outlook isn’t as bleak, with the greenback expected to start falling in late 2023, while Europe and the European single currency remain in similar positions to those of the United Kingdom and the pound.

Goldman Sachs forecasts the exchange rate between the pound and the dollar to fall back to 1.07 over the next few months, but tips the pair to end 2023 at 1.22, while the rate between the pound and the euro is expected fall below 1.14 in the spring of 2023 before ending the year above 1.16.


Source: Goldman Sachs Global Investment Research. Click on the image for a closer inspection.


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