Late on Friday Goldman Sachs noted that “the policy stance in the UK has been on a relatively smooth and steady tightening path, even as the communication from policymakers has been anything but. Neither has been particularly helpful for the currency, especially with other central banks now materially accelerating tightening plans. Perhaps even more importantly for the outlook, Sterling has a relatively high cyclical beta, so it tends to weaken when recession risks are elevated. Taking these together, we see further Sterling underperformance ahead, and are revising our EUR/GBP forecasts higher to GBP0.86, GBP0.87 and GBP0.88 in 3-, 6- and 12-months (from GBP0.83, GBP0.84 and GBP0.85 previously). What could change this path? At some point, the “Reverse Currency Wars” mentality could become more prevalent in the BoE’s mind, with currency weakness exacerbating an already bleak inflation outlook. We do not think that hiking into a cyclical slowdown is negative for the currency - nor is it a problem that is unique to the UK. However, for now, the BoE’s more nuanced approach to balancing the growth and inflation path has negative implications for the currency. Given the negative pressures from the terms of trade shock and more balanced policy response, and to underscore that the cyclical outlook is the primary driver of our forecast changes, we are initiating a new trade recommendation to go long EUR/GBP, with a target of GBP0.86 and stop at GBP0.83. Investors could also consider short GBP/SEK, which would be more sensitive to risk sentiment but should trend lower given relative monetary policy paths across Europe.”
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