Foreign exchange analysts at HSBC predict a move higher in both the Euro (EUR) and Pound Sterling (GBP) against the US Dollar (USD). They identify a combination of factors, including an improved risk appetite environment and unique domestic drivers, that have shaped their optimistic outlook on both currencies since November 2022. The Analysts suggest the Euro to Dollar exchange rate could see 1.15 later this year. They also predict the Pound to Dollar exchange rate could rise to 1.30 in 2023. "We have been bullish on the EUR and GBP since November 2022 and believe both currencies will see further upside through the summer," says Paul Mackel, Global Head of FX Research at HSBC. "This will put more focus on the cyclical upswing in Europe and the UK, which points to further currency appreciation in the months ahead," he adds. Mackel points to three key aspects of the cyclical upswing that are instrumental in tracking the expected currency appreciation. ADVERTIsem*nT "Consumer confidence bouncing – the last few months have seen a sharp jump in consumer sentiment in both economies. This has historically been a good lead indicator for currency performance," says Mackel. "Business outlook improving – corporate surveys are showing their strongest momentum in over a year, especially on the services side, and the forward looking components remain supportive of further upside," he notes. Mackel also identifies disinflation as a key factor, as high inflation driven predominantly by the supply side has been a significant burden on both the Eurozone and the UK economies in recent years. However, indications of peaking inflation and softer price pressures expected through the summer could benefit consumers through the real income channel and limit cost pressures on firms. Despite the relatively bullish outlook for the near term, Mackel urges caution, highlighting early indicators that the positive trend may not extend beyond the summer. A slowing disinflationary impulse and the impact of prior monetary policy tightening could increase downside growth risks later in the year. "There are already signs of this in weaker credit growth and credit demand, which make us reticent to push our forecasts higher right now. As such we maintain our forecasts for EUR-USD and GBP-USD to move higher this year to 1.15 and 1.30, respectively," says Mackel. He concludes by noting that the cyclical improvements are more relative than absolute, and the waning positive impact of disinflation could make it harder for the EUR and GBP to climb even higher, especially if the ECB and the BoE conclude their hiking cycle in the coming months.
Consumer Confidence, Business Outlook, and Disinflation: Drivers of Upswing
Impact of Disinflation and Positioning Adjustment
Positioning for Further Upside
The implications of this could be considerable, particularly if we consider Mackel's assertion that both currencies still have room to rally further. The limited positioning adjustment seen so far suggests that there is still upside potential. Yet, this bullish outlook is tempered by early warning signs that this favourable news may not persist beyond the summer.
"Investors are slowly getting on board with this positive view, especially in terms of flows into the EUR, although GBP remains somewhat unloved. A limited positioning adjustment thus far suggests there is room for both currencies to rally further," says Mackel. "However, we would be cautious of turning even more bullish," he adds.
It's important to note that the improvements observed in various cyclical dynamics are more relative in nature. This means that they are measured against the prior trend and expectations, rather than demonstrating an absolute shift in economic conditions.
"The improvements on many cyclical dynamics are still more relative (versus the prior trend and expectations) than absolute in nature," Mackel points out.
2023 Outlook: Potential Headwinds Ahead
Mackel draws attention to potential headwinds that could limit the potential of the Euro and Pound exchange rates to press even higher than the current projections. Weakening credit dynamics, combined with the diminishing positive impact of disinflation, could increase the challenge for these currencies, particularly if the European Central Bank (ECB) and the Bank of England (BoE) round off their interest rate hiking cycle in the upcoming months.
"And there are early warning signs that ongoing cyclical improvements are unlikely beyond the summer. Weakening credit dynamics and the waning positive impact of disinflation could make it much harder for EUR and GBP to press even higher than our current projections," Mackel warns.
So while Mackel's outlook for the Euro and Pound Sterling suggests a possible uptrend against the US Dollar in the short to medium term, the analyst urges a note of caution. This caution is primarily due to potential headwinds, including the possibility of the ECB and BoE concluding their hiking cycle, as well as weakening credit dynamics and the diminishing positive impact of disinflation.
"Especially if the ECB and the BoE finish their hiking cycle in the coming months," he states, underlining the uncertainty that remains on the horizon.
Nonetheless, Mackel's analysis provides valuable insights for investors and analysts alike, offering a balanced perspective on the potential upsides and risks for the EUR/USD and GBP/USD exchange Rates in the coming months.
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