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Foreign Exchange

Sterling outlook hit by faltering UK growth, says BarCap

Barclays Capital has sharply lowered its short-, mid- and long-term sterling forecasts, citing poor cyclical growth predictions and a more bearish tone from the Bank of England’s Monetary Policy Committee.

BarCap notes persistent weak GDP growth in the first half of 2011, with first-quarter growth of 0.5% only just erasing Q4 2010’s decline, it says in a research note released today (July 5). The bank’s one-month GBP/USD target has been lowered to $1.59 from $1.66; its three-month from $1.72 to $1.58; its six-month from $1.74 to $1.59; and its 12-month from $1.76 to $1.60.

The forecasts are not as pessimistic as UBS’s, which cut its six-month sterling forecast to $1.50 last week. It cited the previous week’s dovish MPC minutes and a change in the committee’s voting pattern as its own decisive factors.

“The usual period of rapid growth as spare capacity is used up has not yet taken place, leading to increasing questions of whether it will ever happen,” BarCap strategists note. The bank characterises the MPC’s dilemma as choosing between issuing further fiscal stimulus versus tightening in the wake of persistent inflation. Ultimately, the bank’s economists conclude, higher inflation will probably keep further quantitative easing at bay, without giving rise to a rate hike.

The UK, with its below-average growth and the highest level of inflation in the G10, is also far more vulnerable to further global supply side shocks than equivalent economies, the bank argues. As the graph shows, UK inflation is a full 1% higher than the next-closest G10 sovereign.

Against the euro, BarCap is slightly more optimistic. It suggests that the relatively high value of the euro against the pound at present should insulate sterling against further weakness, but much depends on the Greek debt crisis being resolved without worsening further. Nevertheless, it expects the euro to push up towards £0.93 within one month, and £0.95 within three.

To profit, the bank recommends buying a one-month 1x2 EUR/GBP call spread, with strikes at 0.92 and 0.95. “At a spot reference of 0.9036, this would cost about 0.32% EUR, giving a maximum payout of about 10:1,” the bank notes. “For those who are unable to trade options, buying EUR/GBP is an obvious alternative.”

The UK has the highest inflation in the G10 but far from the strongest growth

 Source: Haver Analytics