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Last week, the pound sterling was hit by a large sell-off, as the Bank of England predicted a lengthy recession. However, many economists believe the regulator's outlook might be too bleak.
Could the BoE be wrong?
Last week, the UK central bank increased the interest rate for the sixth time to 1.75%. The 50 bps move was the biggest hike in 27 years.
The Bank of England's hawkish move was prompted by soaring inflation. Prices increased by 9.4%, and inflation does not appear to be slowing down.
According to BoE's outlook, inflation will reach 13% in the next quarter and will remain very high throughout most of 2023.
The pessimistic forecast suggests that the regulator would likely continue hiking the rates aggressively at its next policy meetings.
However, rising expectations of monetary tightening did not give support to the pound sterling, which slumped against the US dollar due to increased fears of a recession.The Bank of England has predicted a prolonged and deep recession amid the rate hike cycle, and not an ordinary economic downturn.
BoE policymakers see the recession last for 5 quarters - longer than the previous economic crises of early 1980s and 1990s.
While a recession lasting for more than a year might seem fatal for the pound sterling, many analysts consider the BoE's outlook to be too bleak and say it is too early to write off the pound.
Savvas Savouri, chief economist at Toscafund Asset Management, called the Bank of England's forecast unrealistic.
"I do not accept that a statistical recession looms. Yes, we might, just might see real GDP fall in Q2. Thereafter, I see little or no chance of what the BoE projects will be another decline in Q4," Savouri stated.
According to Savouri, the UK has a stable financial system, a fundamentally healthy property market, both residential and commercial, and a strong labor market with unprecedented hiring intentions at businesses.
"How can the UK economy with its fundamentally robust banks – and financial sector more broadly – misfire? The reality is that the UK economy is in so many favorable dimensions light-years ahead of where it stood in 1979, 1989 and 2008," Savouri said.
The market continues to digest the bleak outlook by the Bank of England. Growing uncertainty over the UK economy's further prospects is affecting GBP/USD.
Today, the pound is stuck in a sideways trend, but is trying to regain 1.2100. It has some support from the weaker US dollar.
Growing concerns about a possible dovish shift in Fed policy is pushing down the dollar. Speculation regarding the Fed's plans intensified in the run-up to the release of US inflation data for July.
The CPI data will be released tomorrow. Economists expect inflation to ease to 8.7% year-over-year from 9.1% in the previous month.
If inflation decreases, the Fed could consider slowing down their monetary policy tightening.
However, the pound's upside potential is limited by several negative factors, preventing it from taking advantage of the situation.
Asides from bureaucratic procedures and political vacuum following the resignation of Boris Johnson, the pound sterling is under serious pressure by macroeconomic factors.
This week, GBP/USD traders are waiting for the UK GDP data release for June and the second quarter, which will be released on Friday.
The UK economy is expected to contract by 1.3% in June and 0.2% in Q2 2022.
According to Capital Economics, the additional bank holidays in early summer caused this decline.
Analysts believe that the UK economy will recover in July. This could reduce recession fears and give some support to the pound.
GBP/USD's price dynamics will depend on data releases this week. However, it is likely to remain predominantly negative.
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