MUFG: The GBP - FJElite

The pound is continuing to hold up better than expected to the worsening energy price shock. It has been the second best performing G10 currency since the US dollar bottomed on 9m September. There was further encouraging evidence last week that the UK economy is continuing to grow more strongly than expected this year which has helped to support the pound. Monthly economic growth unexpectedly picked up to 0.4% in July from 0.3% in June highlighting that growth momentum was much stronger than expected (consensus forecast at 0.0%M/M) at the start of Q3. It follows annualized growth of just over 2% in the first half of this year. Growth is expected to slow significantly in the second half of this year similar to the seasonal pattern evident in recent years although July activity suggests it may not slow as much as feared.

The combination of stronger growth, rising energy prices and building expectations for other major central bks to tighten policy have been encouraging expectations that the BoE will soon take action to begin tightening policy as well. The 2-year gilt yield has jumped sharply by almost 40bps from the low earlier this month, and there are now over 100bps of BoE hikes priced into the year ahead. While we expect the Boe to leave rates on hold this week, we expect the updated guidance to indicate that MPC members are moving closer to voting to a hike as soon as the next meeting in November. Rising yields in the UK which are amongst the highest in offer in the G10 are helping to support the pound while growth holds up. However, the UK labour market has remained weak despite stronger growth. The latest labour market report released this morning revealed another month of bigger than expected private sector job losses totalling -26k in August, and private sector pay growth held at target consistent levels at 2.9%. Weakness in the labour market could curtail the scale of tightening the BoE is willing to deliver.