Economists at Danske Bank think markets are pricing in too many rate hikes from the Bank of England (BoE) short-term. Furthermore, a hit to overall risk sentiment and rising Brexit uncertainties may also weigh on GBP/USD.
The key risk is a shift in the global investment themes
“We believe the current USD-positive investment environment will continue in 2022. Global growth is slowing, liquidity and monetary conditions are tightening, and there is a higher preference for USD assets, which (among other things) are supporting USD. This is usually also an environment where GBP benefits but we think it will benefit USD more than GBP.”
“Both the Fed and the BoE are on track tightening monetary policy. We believe, however, that market pricing is too aggressive on the BoE and too soft on the Fed. We are having a hard time seeing why the BoE should outpace the Fed, as the US economy is in better shape and underlying inflation pressure in the US is higher. Hence, we expect relative rates to weigh on GBP/USD.”
“GBP/USD is likely to move lower if markets are hit by a risk sell-off. Another factor to look out for is the EU-UK negotiations on the implementation of the Northern Ireland protocol. While we expect neither the EU nor the UK to use the nuclear options, we will not be surprised if tensions rise, which may weigh on GBP/USD.”
“If high inflation fades faster than we expect, if central banks get more accommodative (or stop tightening as fast as currently expected) and if we see a turn in the manufacturing cycle, we could see GBP/USD moving higher. The same goes if the BoE is forced to step on the brake to stop high inflation.”