Sterling holds on to its gains
Sterling remains one of the currency markets 2023’s top performers. Forecast beating economic data releases along with sticky inflation has driven the Bank of England to aggressively hike interest rates, which in turn has supported the Pound for most of the year. Inflation aside, whilst a series of UK economic releases have been positive leaning, it’s striking that the market remains disposed to a pessimistic bias towards the UK. Sterling has never been one for sudden spiked rallies, but a post Brexit devaluation of fair value is a physiological fact for many. JP Morgan cites their own estimates of fair value for Sterling against the US Dollar to be 1.20, with BNP Paribas models suggesting 1.21. This viewpoint creates the bias in the market, leaving the momentum from positive data capped, with rallies easily retraced by slightly negative data releases.
2023 ranges revised up – time to hedge?
Should Sterling continue to hold on to its year-to-date gains, Banks may increase their fair value estimates. The inflation and interest rate story powered Sterling to exceed 1.31 (versus the US Dollar) for a few sessions earlier in the summer. As a result, for this publication the forecasted 2023 range for Sterling versus the US Dollar is being revised upwards, 1.2250 to 1.3250, previous expected range was 1.1650 to 1.2650. For Sterling versus the Euro, the range forecast remains unchanged at 1.1050 to 1.2150.
Currency risk occurs when there is the potential for the price of one currency to change in relation to another. Small and medium-sized businesses that buy or sell across borders are often among the hardest hit by currency volatility. Hedging currency risk is an essential tool for businesses that work in a currency other than Sterling because it helps them to manage their costs and forecast their profits.
With Sterling performing better than expected, many businesses are now considering hedging their currency exposure. Forward exchange rates are predominately based on expected interest rate differentials between the currencies involved. UK interest rates are expected to higher than others for the next few years. Against the US Dollar a premium of half a cent reduction is currently priced into the one year forward rate.
More strikingly, the differential in expected interest rates for the UK and Euro area has increased the cost of hedging significantly in recent months. A one year forward rate GBP/EUR is trading over 2 cents lower than the current spot rate, compared to less than a cent only a few months ago. The implication is the European Central Bank will be able to reduce interest rates and the Euro inflation tumbles, whilst the Bank of England will stick with higher rates for longer.
With cost pressures still a challenge for Businesses, reviewing the costs being incurred and the strategy of managing currency exposure becomes even more important. Specialist support as provided by companies like Ascendant, can fill a gap not provided by larger financial institutions. Cambridgeshire headquartered, Ascendant would love to hear your views and perspective on The Pound, its expected performance, and the impact to your business. Just contact us on the email below. Ascendant offers Chamber members a free review and benchmark of their current supplier, contact us to hear how we are reducing the cost of foreign exchange for local businesses, and putting relationships at the heart of our customer focused service.
