Foreign exchange analysts at MUFG expect central bank interest rate decisions will dominate the Pound to Dollar exchange rate (GBP/USD) outlook.
Despite the possibility of an early Bank of England (BoE) interest rate cut, MUFG considers that pessimism over US interest rate cuts is now overdone and is sees scope for GBP/USD to strengthen to 1.2950 at the end of 2024.
GBP/USD dipped to 5-month lows just above 1.23 in April before a recovery to 1.2530.
MUFG notes increased evidence of divisions within the BoE Monetary Policy Committee (MPC) with Governor Bailey and Deputy Governor Ramsden more confident that inflation will decline to target, but chief economist Pill less confident.
At this stage, MUFG is still backing a first rate cut in June, although it would be no surprise if the move is delayed until August.
As far as US interest rates are concerned, markets are now pricing in only one rate cut this year and expect that the BoE will cut rates ahead of the Fed.
MUFG considers that the shift in US expectations has gone too far, and it still sees the potential for three rate cuts this year.
The bank also sees very little scope for a further increase in US bond yields from current levels, limiting the scope for further dollar buying.
KEY QUOTES:
"The pound weakened versus the US dollar but was close to unchanged versus the euro highlighting the influence of the US dollar..."
"The BoE rate cut expectations continue to remain between less being done by the Fed and more being done by the ECB."
"We are maintaining our view of the BoE cutting rates in June although admittedly the risk is certainly skewed in favour of a hold..."
"However, comments from Governor Bailey and Deputy Governor Ramsden suggest both could potentially vote in favour of a cut by then."
"Incoming economic data going forward is likely to send mixed signals in terms of the timing of a rate cut."
"Compared to a month ago we hold more conviction that the US yield curve has moved too excessively away from pricing cuts..."
"We assume therefore that there will be limited divergence between the UK and the euro-zone and forecast a relatively flat profile..."
"While a June cut would be a close call, the drop in annual CPI to below 2.0% coupled with confidence of slowing wages as employment growth slows, we see it as more likely that the MPC votes to cut in June."