Quid’s in

World-beating Britain is at it again.

GBP is the best-performing G10 currency this year:

Cable recently touched its highest level since last summer:

And TS Lombard is shook. From Skylar Montgomery:

After a disastrous 2022, when GBP/USD saw a >20% peak to trough decline, GBP is thus far the 2023 winner. Viewed as a time series, GBP trade- weighted and vs the majors looks more like a range trade that has just broken out. Regardless, the outperformance is remarkable. We did not envisage the pound being the 2023 outperformer, so this publication analyses what we missed and whether an overweight is now warranted.

Deutsche Bank, which turned sterling Stan at the turn of the year, is smug. Shreyas Gopal writes:

The thesis we outlined at the start of year and reiterated two weeks ago has largely played out. With the market going into the year too short pounds amid overly gloomy expectations, the absence of negative news and robust data have been enough to push Cable to around our initial target from the January Blueprint of 1.25.

What’s going on? Montgomery points out that after some messy governance and doom-laden Bank of England forecasts late last year, it quickly became clear that things were . . . actually kind of OK upon the sceptred isle:

While there is no doubt the UK economy remains under stress — recession probabilities are the second highest in G10 at 75% — the growth outlook has turned more positive. Falling energy prices and a more sensible budget meant that the economy escaped contraction in 4Q22, while January GDP saw a rebound. The result is that as consensus GDP expectations have been revised up, the economy has beaten them with economic surprises entering positive territory at the start of March.

The UK’s economy has surpassed expectations partly because the Bank of England has set those expectations incredibly low. In a note yesterday, reckons Panmure Gordon’s Simon French looked at the BoE’s big forecasting miss:

Central banking has more constraints than many keyboard warriors like to assume. Furthermore Q4 2022 was an acutely difficult period in which to model the outlook for the UK economy amidst huge volatility in financial conditions and energy prices. However, the fact remains that the Bank of England’s forecast for the longest UK recession in one hundred years — eight successive quarters of shrinking output — and a peak-to-trough decline in UK output of 2.9% now looks set to be very wide of the mark.

Some of this forecasting error was inevitable as European energy prices pulled back sharply after the Bank’s November forecasting round. However, as we noted at the time, there were other elements of the Bank’s economic outlook — robust labour demand, household savings, an ongoing global output gap, and fiscal support for household incomes — where we believed the Bank were being too pessimistic.

Markets love a well-timed underpromise-and-overdeliver manoeuvre! French compares the OBR and BoE forecasts and the difference is striking:

Given the size of the shift, it’s hardly surprising that sterling has a spring in its step. But the boost, as Montgomery notes, may not be coming from inside the UK:

Yes, the UK economy surprised to the upside in 2023, but it was not the only economy with positive economic surprises; in fact, the UK was the last economy in the G4 to have its ESI turn positive in 2023, indicating growth differentials that disfavoured the pound until very recently.

Moreover, the market has been expecting a BoE pause for months now, putting something of a ceiling on UK yields; for this reason, rate differentials have largely not been in the pound’s favour . . . 

The pound benefited at the start of the year because of its high-beta status: resilient global demand meant a strong risk on bid. In the past month, the drivers have shifted, with the pound benefiting because of its limited exposure to the banking crisis.

We’d agree that the UK did well during the banking crisis (though HSBC shareholders may disagree) — but it’s clear that “not as crap as expected” isn’t the strongest narrative to drive future growth.

Deutsche’s Gopal concurs that the easy yards are already behind the pound:

On the data, most of the good UK news is now likely in the price. The market has converged to our view that UK growth expectations can be upgraded in line with other major economies for this year, though our house view is still more optimistic than the new consensus

In the micro, the move in the currency over the past month looks a little overdone versus relative rates performance, with the added kicker that the market is still mostly pricing another hike by the BoE at the May meeting but our base case is for a hold.

There are hints that traders are cooling on cable as well, with net non-commercial positioning on sterling turning a bit more bearish in recent weeks:

April might continue to be pleasant, however. As BofA’s Kamal Sharma — certainly not a GBP uberbull — points out, April tends to be sterling’s best month, something which may be down to dividend payments or the timing of the tax year:

But as the left-hand chart shows, April is an increasingly cruel month for the quid. Sharma:

We are not jumping to conclusions as the period from 2017- has also been impacted by other events such as the pandemic and geopolitical tensions. But we cannot ignore the fact that positive seasonality has been less of a given since 2016. But if seasonality is still a pervasive driver for GBP, our previous analysis suggests that seasonality does not kick-in until at least 10 days into the month. This adds some credence to our view above that the tax year may also be playing a role in repatriation flows.

Is there a lesson in all this? As ever, it might just be that markets and economic growth are difficult to predict.

Or, if you’re Blighty-based and want to be more practical, buy your travel on Monday after the bank holiday. Don’t say we never do anything for you.

Further reading
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