G10 FX Weekly: GBP Downside to Accelerate in Q4
- By Richard Jones
- 5 min read
- With a softening economy and more dovish central bank, we think GBP downside will accelerate into Q4.
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Summary
- The UK economy is showing signs of slowing, and this is set to continue into Q4 and beyond.
- Market expectations for Bank of England (BoE) monetary policy have tilted dovishly in recent months. This trend has room to run further.
Market Implications
- With a softening economy and more dovish central bank, we think GBP downside will accelerate into Q4.
- Short GBP/USD. We expect the pound to trade back to its year-to-date (YTD) low near 1.18 versus the USD.
- Short GBP/CAD. We also expect the pound to trade back to its YTD low versus CAD, near 1.61.
Introduction
Of all the G10 currencies, we are the most bearish GBP.
This is due to market expectations of BoE monetary policy still being too hawkish, together with a deteriorating UK economy. This combination stands out among developed markets and will lead to material GBP downside into yearend.
As a result, we like being short GBP/USD and GBP/CAD.
BoE Pricing Is Still Too Hawkish
We have been calling for lower UK yields for a few months now, arguing that market pricing of the BoE was far too hawkish. The UK short end has been our favoured position across the G10 rates space, and we have been received the UK short end for several weeks.
Even though market pricing of the BoE has tacked more dovishly since we opened our received position, we still think UK short-end yields have room to fall further in the coming weeks and month.
The market still prices additional BoE tightening, and we think this is too hawkish.
Macro Hive guest author Vasileios Gkionakis recently argued that the market is underpricing BoE rate cuts next year. We agree with this and his expectation of more downside for the pound as a result.
UK Job Market Is Loose (and Loosening)
Our Macro Hive colleague Henry Occleston has long argued the UK job market is softer than markets generally think.
Last month, Henry broke down the labour market report, arguing the details pointed to a loosening job market with dovish implications for the BoE. Higher unemployment, stabilising pay growth, and a shift in employment composition all contributed to Henry’s assessment.
Continuing market looseness is evident in the most recent employment data (partially released this week, with the balance set for release next week).
Average weekly earnings for August (including bonuses) were weaker than the previous reading (8.1% actual vs 8.5% in July) and weaker than expected (8.3% expected).
Additionally, the September monthly change for payrolled employees at -11,000 was weaker than the previous reading of -8,000 and the expected +3,000.
We must wait for the other details out next week but, of the components already released, the labour market loosening is proceeding apace. See Henry’s take on the jobs data, plus other BoE thoughts, here.
On top of all this, a Bloomberg piece recently noted the ‘Sahm Rule’ (named after US economist Claudia Sahm) is pointing towards a UK recession.
The Sahm Rule ‘indicates the start of a recession when the three-month moving average of the unemployment rate rises by 0.5 percentage points or more relative to the low during the previous 12 months.’
All the above points to a looser (and loosening) UK labour market, which will weigh on consumption and drag on the broader economy. This will also create a strong headwind for sterling in the coming months.
Dovish Details Dominate September UK CPI
Although UK inflation data released yesterday was slightly stronger than expected, we do not see it as a game-changer for the BoE or UK economic outlook.
Henry suggests the details of the CPI report are dovish. While headline YoY slightly beat consensus expectations by remaining unchanged at 6.7%, core at 6.1% was slightly weaker than the previous reading of 6.2%.
Perhaps most importantly, both inflation measures were weaker than expected in the BoE’s August Monetary Policy Report (MPR).
And, while services inflation ticked higher last month, Henry maintains that the underlying picture is dovish – wage-intensive services inflation continues to trend downwards, helped by labour market loosening.
Taken together, September’s inflation data will not turn the BoE more hawkish. As such, the BoE’s November MPR should be dovish.
This contrasts market pricing of additional BoE tightening. We expect this to unwind and, with it, the pound to drop.
GBP Is Poised for Additional Downside
Since mid-July, sterling has declined just over 3% on a trade-weighted basis.
Soft UK economic data, leading to a more dovish BoE, has been the big driver of this downtrend. We think these dynamics can continue and will lead to additional GBP downside into yearend.
Two FX pairs we like being short are GBP/USD and GBP/CAD.
GBP/USD
Dollar strength has been relentless over the past three months, although in recent weeks USD strength has moderated somewhat, resulting in a mini-correction higher.
We think that GBP/USD downside can resume, with the pair set to revisit the YTD low near 1.18.
The pair’s reaction to the important UK data this week has been telling. After initially trying to push higher, GBP/USD now trades lower than last week’s close.
Expect more of the same into yearend.
GBP/CAD
GBP/CAD had an impressive move lower from mid-July until late September, falling from ~1.73 to ~1.64.
In the past few weeks, the pair has bounced, and we like fading this move. Given our expectation for GBP/USD, we think that GBP/CAD will also trade lower, back to its YTD low near 1.61.