The British pound was weighed down by weak domestic data, which showed that the UK economy is under stress from the rising cost of living. This has forced investors to cut back their expectations on future interest rate hikes by the Bank of England. With limited economic releases from the UK, the pound could drop further against the US dollar, analysts have warned.

The US dollar has strengthened as a safe-haven currency following concerns about supply-chain issues, a coronavirus-related lockdown in Beijing and the ongoing war in Ukraine. The prospect of aggressive Fed rate hike bets and the risk-off mood have pushed the US dollar to over a two-year high. On the other hand, diminishing expectations for further tightening by the BoE have pushed the pound lower.

Bank of England (BoE) to disappoint market expectations

Economists at Scotiabank have reported that the Bank of England may disappoint markets. They noted that if yield differentials go even lower, then the pound to US dollar exchange rate could fall lower. As they said, “The spread of 2-yr Gilts vs USTs has oscillated around -1% for the past four weeks or so but looks set to mark a new pandemic low in the coming weeks that would drive additional GBP weakness.” They added: “Another leg lower in yield differentials amid a cautious BoE vs a hawkish Fed (as well as some near-term political anxiety ahead of the May 5 local elections) could fuel GBP losses.”

Economists at ING also expect the pound to remain fragile. They said that one of the central themes of this year will be whether Central Banks will proceed to further tighten their monetary policy amid a global economic slowdown. It remains to be seen whether the Bank of England will tighten its policy. They believe is too early to write off Sterling especially against the euro.

Recession risks in the UK

Economists at Deutsche Bank have warned that recession risks in the UK are growing following the cost-of-living crisis. Sanjay Raja, Senior Economist at Deutsche Bank, said that "recession warnings are burning brighter," with inflation (CPI) expected to reach 9% year-on-year in April and October this year, which is "drastically hitting spending power.”

With tax rises biting into household budgets, consumer confidence has fallen considerably, while real wages are expected to shrink by 4% in 2022.

Raja warned that "The risk of a household recession may be even greater (household consumption shrinking), given the confluence of factors plaguing consumer spending.”

Such fears have contributed to markets lowering their expectations for future Bank of England interest rate rises. This in turn has pushed the pound exchange rates lower.

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