The British Pound (GBP) has maintained its recent gains against the Euro (EUR) and most of the G10 currencies during the initial week of 2024, primarily due to diminishing speculations of interest rate cuts. The currency's resilience is bolstered by a closely monitored survey of the UK labour market, revealing sustained wage pressures towards the end of the year. This has tempered expectations of an imminent interest rate reduction by the Bank of England (BoE).

The REC/KPMG Report on jobs survey disclosed an upturn in rates of pay growth from the lows observed in November. Additionally, the survey indicated a slower decline in both permanent placements and temporary billings. In December, the index for permanent staff salaries rose to 56.5, up from 56.0 in November, while the permanent staff placements index increased to 45.6, compared to 41.6 in November.

As the year commenced, the USD emerged as the top-performing major currency, closely followed by GBP. The key factor driving this outperformance of GBP and USD is the easing of expectations regarding the magnitude of anticipated rate cuts by both the Federal Reserve and the BoE. The BoE maintains that a rise in unemployment and a significant wage decline are necessary to bring UK inflation back to the 2.0% target consistently.

The Bank will only signal the need for interest rate cuts when it believes that inflation is on track to meet the target, with wages playing a pivotal role in this assessment.

The upcoming data schedule for the week includes a speech by the UK BoE Governor Bailey on Wednesday and the release of GDP m/m on Friday. Additionally, the US core CPI m/m and CPI y/y data will be released on Friday. Market participants will closely scrutinize these indicators for clues pointing towards a more gradual pace of interest rate cuts than initially anticipated at the beginning of the year.  GBP could continue to receive support if expectations of rate cuts further diminish.

The British Pound dominated as the top-performing major currency in 2023 until August, when it became evident that the slowing inflation would eliminate the necessity for the Bank of England to raise interest rates to the previously implied 6.5%.

The anticipated deceleration in UK inflation materialized, reaching its peak with the December release showing a substantial slowdown in November. Consequently, markets have heightened their expectations for rate cuts, causing the Pound to rank as the second-worst performer in the G10 over the past month. Despite this recent decline, the UK currency maintains its position as the second-best performer in the G10 for the entirety of 2023, with only a few trading days left.

Looking ahead to 2024, the focal point for currencies will be the timing and magnitude of central bank rate cuts. If the Bank of England initiates cuts before its counterparts, the Pound may face challenges. However, delaying the cuts could allow UK yields to outperform, potentially leading to a resurgence in the Pound's value.

According to NatWest, the British Pound is expected to steadily appreciate against the Euro and Dollar until around the third quarter of 2024, at which point gains may recede as the Bank of England implements interest rate reductions.

TD Securities anticipates the first cut from the Bank of England in May, while the Federal Reserve and the European Central Bank are forecasted to follow suit in June. If the Bank of England leads the rate-cutting cycle, Pound Sterling could experience pressure, reflecting a faster decline in UK bond yields compared to those of the Eurozone and the U.S.

Projections for exchange rates indicate that the Pound to Dollar exchange rate is expected to be 1.24 by the end of March, 1.27 by the end of June, 1.31 by the end of September, and 1.30 by the end of the year. The Euro to Pound rate is projected to be 0.87, 0.85, 0.87, and 0.88 at these respective time points, resulting in a Pound to Euro profile of 1.15, 1.18, 1.15, and 1.14.

GBP experienced a decline in response to the surprising news that inflation in the UK decelerated more than anticipated in November. Following the announcement by the Office for National Statistics (ONS) that inflation had decreased by 0.2% month-on-month in November—compared to October's 0% and below the market's expected 0.2% increase—the GBP/EUR exchange rate dropped by 0.40% to 1.1545.

In terms of year-on-year comparisons, CPI inflation for November stood at 3.9%, a decline from October's 4.6% and lower than the market's forecast of 4.3%. This unexpected turn of events led to a 0.38% decrease in the GBP/USD exchange rate, settling at 1.2660. Investors interpreted this as an indication that there had been sufficient progress in inflation for the Bank of England to consider potential interest rate cuts in 2024.

Specifically, the closely monitored services inflation level, a key concern for the Bank of England, eased from 6.6% year-on-year to 6.3% in November. Core inflation, which excludes energy and food, providing a more accurate reflection of domestic inflation pressures, increased by 5.1% year-on-year, a drop from the previous 5.7% and below the expected 5.5%. This unexpected dip was underscored by the fact that even the most conservative estimate among the 28 economists surveyed by Bloomberg was 5.2%.

The November outcome resulted from an unforeseen -0.3% month-on-month reading, down from October's 0.3% and below the consensus expectation of 0.2%. While GBP experienced a short-term setback, the decrease in inflation is favourable for UK consumers and enhances the overall economic outlook of the UK. In the medium term, this development is expected to provide support for GBP.

GBP starts the upcoming week with a positive technical momentum, indicating a favourable outlook against both the EUR and USD. However, the release of midweek inflation figures may pose a challenge to recent advancements.

GBP received a boost from the Bank of England's latest policy decision and guidance, where the Bank cautioned that inflation risks remained elevated, and the possibility of further rate hikes could not be definitively ruled out. This message was reinforced on Friday by December PMI figures, revealing a surprisingly robust increase in economic activity. The survey also highlighted persistent price pressures in the services sector, lending credibility to the Bank of England's guidance and supporting the Pound.

In contrast, Eurozone PMI figures disappointed, raising doubts about the European Central Bank's assertion that interest rates would stay higher for an extended period. This disparity in economic performance between the UK and the Eurozone was reflected in the rise of the GBP/EUR rate.  Observers of this exchange rate should note that GBP/EUR has struggled to surpass 1.17 consistently in 2023, and caution is advised against expecting a sustained rally above this level.

The forecast for the GBP/USD exchange rate in the week ahead is optimistic, fuelled by the +1.5% surge observed last week, contributing to a positive momentum dashboard advocating for further gains. The rebound above 1.27 follows the U.S. Federal Reserve's guidance last week, which tacitly supported market expectations for multiple rate cuts in 2024. Fed Chair Jerome Powell's acknowledgment of the risks of maintaining restrictive interest rates for too long influenced this development.

However, GBP/USD faced a setback on Friday following comments from Federal Reserve board member John Williams, injecting a dose of reality into the exuberant market response to the Fed's midweek interest rate decision and guidance update.

This week's UK inflation data, scheduled for release on Wednesday at 07:00 GMT, has the potential to reinforce the recent GBP-supportive narrative if it exceeds expectations. The consensus forecast anticipates a year-on-year CPI inflation rate of 4.3%, down from the previous 4.6%, with the core CPI reading expected at 5.5%. A lower-than-expected outcome could exert pressure on GBP cross rates during the midweek session.