GBP/USD: Pound likely to drop before bouncing higher later in 2022 – MUFG

Uncertainties around Brexit remain but the influence on the exchange rate will diminish further according to analysts at MUFG Bank They forecast GBP/USD at 1.3170 by the end of the first quarter and at 1.3730 by the third. Regarding the EUR/GBP they forecast at 0.8350 by the end of Q1 and at 0.8300 by Q3. 

Key Quotes:

“The pound was the second best performing G10 currency in 2021 which we believe in part reflects some catch-up after being the third worst performing G10 currency in 2020. The global lead in covid vaccinations played an important role in GBP performance over the whole year.”

“Like with a number of other G10 countries, the OIS market pricing for rate hikes this year looks excessive to us. At the time of writing, the 1-year forward OIS implies close to 100bps of monetary tightening. After the annual CPI jump in November to 5.1%, the BoE acknowledged in its December statement when it raised rates that inflation would hit 5.0% through the winter months and peak at about 6.0% in April, reflecting the jump in utility bills. But under this scenario, the MPC guidance in December was that further “modest tightening” of monetary policy would be required. We do not view what is priced in the OIS market over the next 12mths as modest and we suspect at some stage in the coming months, the markets will pare back monetary tightening expectations.”

“This paring back of rate hike expectations will see GBP underperform versus the US dollar before gains materialise in the second half of the year. By then we assume the uncertainty over the Northern Ireland protocol will have been resolved. There is of course a risk that this issue escalates again and undermines GBP performance but we suspect each passing year will see less and less impact in FX from Brexit uncertainties. Problems related to the rising cost of living at a time of rising taxation will dominate the political landscape this year.”

“We are maintaining our profile of GBP underperformance initially versus the US dollar before recovery takes hold later in the year. The BoE signalling greater caution perhaps following a Feb rate hike will curtail GBP strength over the near-term.”