Image © David Holt, Accessed: Flikr, Licensing Conditions: Creative Commons
The British pound will grind lower amidst slowing economic activity and remedial interest rate cuts from the Bank of England says Goldman Sachs.
Economists at the investment bank say the pound will extend a run of weakness as the Bank of England steps up the pace it cuts interest rates in response to a flailing economy.
"The incoming information supports our expectation for a Bank Rate cut on December 18, with three further cuts in 2026," says a new note from the bank.
Data out this morning cast a pall over the UK economy, confirming a slowdown that will encourage a more activist Bank of England:
- Flash PMI for November fell to 50.5 from 51.8, marking a sharp slowdown.
"Growth eased markedly since October" - S&P Global, compilers of the PMI survey. - UK Consumer Confidence Index fell by two points to -19 in November.
"This is a bleak set of results as we head towards next week’s Budget" - Neil Bellamy, Consumer Insights Director at GfK. - UK retail sales: -1.1% year-on-year in October, versus 0% expected.
"Weakness was relatively broad-based: food store sales were down by 1.1% and clothing and footwear store sales fell by 3.3%" - Sandra Horsfield, an economist at Investec. - UK government borrowing: £17.43BN versus £15.2BN expected and head of the OBR's projections by £3.1BN.
"October borrowing illustrates the difficult backdrop to the upcoming Budget. Borrowing has now overshot the fiscal watchdog’s projections in four of the seven months" - Elliott Jordan-Doak, Senior U.K. Economist at Pantheon Macroeconomics.
GBP/EUR fell to 1.1330 after the PMI data's release, indicating it's where traders were focused on Friday, extending November's decline to 0.60%:
Above: GBP/EUR at monthly intervals.
The pound has come under sustained pressure as investors join a household and business retrenchment ahead of the November 26 budget where some £30BN must be raised in taxes.
Economists at Goldman Sachs say UK dataflow is soft enough, and the inflation outlook benign enough, for the Bank to cut in December and continue easing through 2026, ultimately taking Bank Rate down to around 3% by next summer.
This defies market expectations for a little over just two more cuts, the final being by April next year.
Where this becomes particularly important for FX markets is the gap between what the Bank is likely to do and what markets are currently priced for.
Above: UK economic growth is trending slower again. Image courtesy of Goldman Sachs.
Goldman’s FX strategists argue that if the Bank delivers a deeper easing cycle than expected, the pound is left exposed.
"Our FX team sees greater sensitivity of regional Sterling performance to the data than shifting fiscal risk premia and expect EUR/GBP to drift higher still," says a UK economic note released this week.
The pound to euro rate is meanwhile seen trading well below consensus forecasts for year-end, raising the prospect of a relief-style rebound into year-end.
However, gains should be shallow if analysts at Goldman Sachs are correct.
Their reasoning for a path of more aggressive cuts is straightforward: inflation is behaving.
October CPI fell to 3.6%, exactly in line with the Bank of England’s own projections, and services inflation has eased further.
Pay growth is normalising too, slipping to 4.2% and coming in a touch below the MPC’s latest forecast.
Labour market slack is building, unemployment has risen to 5%, and payrolls are falling. Growth remains weak, with September GDP contracting and business surveys still subdued.
Taken together, the data point toward fading domestic inflation pressure, and the Bank of England has started to acknowledge that publicly.
Governor Bailey noted earlier this month that December offers “more data” to confirm whether the disinflation path is becoming established, and Goldman read that as a clear sign that a cut next month is highly likely.
"Our strategists’ expectation remains long UK rates and short Sterling (versus the Euro) on our disinflationary view for the economy," says Goldman Sachs.