Investing.com — UBS strategists maintain a bearish outlook on the British pound, targeting at 0.89 by the end of the second quarter and GBP/USD at 1.31, citing risks from the ongoing Middle East conflict and its impact on energy markets.
The pound has strengthened roughly 1.3% against the euro since February 27, supported by a sharp sell-off in front-end GBP rates that exceeded EUR rates. This rates repricing has overshadowed the underperformance of long-end gilts and general risk-off sentiment, factors typically associated with pound weakness.
UBS views the risks as heavily tilted to the downside for sterling in the near term. The bank’s first-quarter target of EUR/GBP 0.88 may prove ambitious with just three weeks remaining in the quarter.
For , UBS targets 1.33 at the end of the first quarter and 1.31 at the end of the second quarter, aligned with its revised EUR/USD forecasts of 1.16 for both periods.
The bank outlined several reasons why sustained pound strength appears unlikely if the conflict continues and energy supply disruptions persist. A negative growth shock from higher energy costs combined with elevated gilt yields poses challenges to the UK’s fiscal outlook, a key market concern.
Government policies aimed at cushioning the impact on consumers could add further pressure.
Higher energy costs would likely cause a deterioration in the balance of payments through a terms-of-trade hit. The broad basic balance could also suffer if overseas investors become more cautious about gilts.
An inflationary shock into a weak economy would likely result in demand destruction, unlike in 2021 and 2022 when demand was supported by pandemic stimulus and excess savings.
A looser labor market makes it harder for wage growth to keep pace with inflation, squeezing real incomes and hitting consumption. Business investment would likely suffer as a weaker consumer makes it more difficult for firms to maintain profit margins by passing on higher input costs.
A quick resolution in the Middle East and subsequent correction lower in oil and gas prices could trigger a reversal in front-end rates, removing the recent support for the pound.
UBS’s second-quarter target of EUR/GBP 0.89 was originally based on expectations that sterling would face pressure until mid-year due to elevated domestic political risks, likely to be in focus after the May 7 local council and devolved parliament elections.
While attention has shifted to geopolitics, these domestic political risks remain in the background.
The bank previously expected sterling to recover in the second half of the year as political uncertainty fades, targeting EUR/GBP 0.85 for year-end.
UBS maintains this target but notes that key components of the longer-term positive view are at risk if the conflict drags on and energy costs remain elevated. These components include a benign balance of payments backdrop, reduced fiscal premium, low energy costs relative to recent years, and improved business investment potentially feeding through to productivity.
UBS economists now expect the Bank of England to hold rates unchanged at next week’s Monetary Policy Committee meeting on March 19, in line with current market pricing. This is due to uncertainty around the potential inflationary shock from the spike in oil and gas prices.
Inflation expectations have been a key consideration for MPC members at recent meetings, so anything that risks de-anchoring expectations will likely warrant caution about further easing.
UBS economists forecast 25 basis point cuts in April and July to a terminal rate of 3.25%, but note the risk is clearly for fewer or later cuts depending on how the situation in energy markets evolves.
