BBH sees GBP/USD falling to 1.3100 on UK growth risks and politics

The British Pound faces headwinds from a deteriorating UK growth outlook and domestic political risk, even as markets price 64 basis points of Bank of England rate hikes over the next 12 months, according to Brown Brothers Harriman.

"We expect GBP/USD to fall to 1.3100, reflecting a stronger US growth outlook relative to the UK," said Elias Haddad, senior currency strategist at Brown Brothers Harriman. "BoE rate hikes in a sluggish growth, high inflation environment is not bullish for GBP but should help cushion the downside."

UK April GDP data due Thursday is expected to show a 0.1% month-over-month contraction, reversing March's 0.3% expansion and tracking below the BoE's baseline second-quarter forecast of 0.1% quarter-over-quarter growth. Purchasing managers' index data point to an even steeper decline of 0.2% q/q in Q2, Haddad noted. Meanwhile, the swaps curve implies 64bps of BoE tightening to between 4.25% and 4.50% over the next 12 months, driven by upside risks to second-round effects in price and wage-setting from the energy shock. A first full 25bps rate increase is priced in for the Sept. 17 meeting.

The political backdrop could amplify any Pound undershoot. The June 18 Makerfield by-election has become a flashpoint, with recent polls showing Labour's Andy Burnham holding a 10-point lead over Reform UK. A Burnham victory could clear a path for his return to parliament and a leadership challenge to Prime Minister Keir Starmer. "A Burnham-led Labour government will likely lead to more spending and borrowing, worsening UK fiscal credibility," Haddad said.

The UK's growth-inflation mix mirrors a broader pattern across developed economies, where central banks face the challenge of tightening policy into slowing activity. The European Central Bank is expected to deliver a 25bps rate hike to 2.25% on Thursday, its first increase after a seven-meeting pause, as Eurozone core CPI rose to a 13-month high of 2.5% year-over-year in May. Services CPI surged to a seven-month high of 3.5% y/y, raising the risk of persistent inflation. BBH forecasts EUR/USD to fall to 1.1400, reflecting a stronger US growth outlook relative to the Eurozone.

The US dollar has strengthened broadly after Friday's solid jobs report. May nonfarm payrolls rose 172,000, nearly double expectations, while the three-month average payroll gains increased to 188,300 per month, the strongest since March 2024. The unemployment rate held steady at 4.3% for a third consecutive month. Fed funds futures now fully price in a 25bps rate hike to a target range of 3.75% to 4.00% by year-end, with nearly 50bps of tightening expected over the next 12 months. Attention shifts to Wednesday's May CPI report, where headline inflation is expected at 4.2% year-over-year, the highest since April 2023.

The Bank of Canada is widely expected to keep its policy rate on hold at 2.25% for a fifth straight meeting on Wednesday. The swaps curve prices in 50bps of rate hikes over the next 12 months, though BBH sees room for those bets to adjust lower given Canada's contained inflation backdrop. USD/CAD faces immediate resistance at 1.3967, with the next target at the November 2025 high around 1.4140.

For the Pound, the divergence between a weakening UK economy and rising rate expectations creates an unusual dynamic. The last time the BoE faced a comparable stagflationary setup was in late 2022, when sterling fell to an all-time low of 1.0350 against the dollar before recovering on emergency fiscal intervention. While the current situation is less acute, the combination of slowing growth, sticky inflation, and political uncertainty leaves the currency exposed to further downside, particularly if the Makerfield by-election triggers a shift in the UK's fiscal trajectory.

This article is for informational purposes only and does not constitute investment advice.