Goldman: Stay Short Vs EUR

Goldman Sachs note that “the BoE laid out a policy path that is very different from its peers and likely to lead to further currency depreciation. Most notably, the staff forecasts showed inflation returning close to target even without any further rate hikes, and a small undershoot of inflation if rates follow the market-based path. Officials explained that this is because the majority of the inflation moderation in their outlook is driven by an assumption that supply disruptions will ease - i.e. the “transitory” argument.”

• “The reason this matters now is that other central banks have moved on from that thesis. For example, Fed Chair Powell recently argued for a “expeditious” normalization based in part on a shift in strategy; he said that, after repeated disappointments, the FOMC would be setting policy based on “actual progress” on the supply side “and not assuming near-term supply-side relief.” This change in strategy means that other central banks are now responding more forcefully to the shifting inflation outlook than the BoE, which is weighing on GBP. Exchange rates respond to policy reaction functions, and the relative shift in front end differentials has been smaller than implied by the change in the inflation outlook for most of 2022. Even though we have revised down our Euro area growth forecast 50% more than in the UK, EUR rates have sold off by much more, which is a net positive for EUR/GBP.”
• “We have grown increasingly negative on GBP over the last couple of months because of these dynamics, and last week’s BoE decision increased our conviction. For this reason, we are raising the target and stop on our long EUR/GBP trade recommendation to GBP0.8700 and GBP0.8450, respectively. As price action demonstrates, the trade also benefits from being slightly defensive in nature, with GBP typically highly sensitive to global equity outflows.”