The British industrial sector remains mired in contraction, house prices are falling, labour markets are softening, and a broad array of underlying growth indicators are pointing to slowing momentum. With the full impact of higher policy rates yet to hit home, most forecasters currently expect the economy to exhibit stagflation-esque characteristics in 2024 – consensus estimates show inflation topping 3.1 percent while a mild, front-loaded recession leaves growth below 0.4 percent by year end.

2024 consensus forecasts, averaged across data providers

It is increasingly obvious that price pressures in the UK have simply lagged their international counterparts in this cycle, and are likely to fade at a relatively comparable pace in the early new year. All-items inflation rose just 3.9 percent in the year to November, the slowest pace since September 2021, and core – which has trailed headline inflation in all major developed economies, fell to 5.1 percent from 5.7 in the prior month – led by a slowdown in services growth.

Consumer Price Indices, annual % change

Speaking in Capetown this August, Bank of England Chief Economist Huw Pill suggested that the central bank’s policy path could resemble the broad and flat “Table Mountain” which looms over the southern tip of Africa. Under this scenario, he argued, rates wouldn’t need to climb a lot higher, but might have to remain at elevated levels for a prolonged period to bring inflation risks down.

Thus far, his colleagues have signalled agreement. In contrast with their counterparts at the Federal Reserve – who have acknowledged they could begin cutting in the early new year – British officials have maintained a firmly hawkish bias in recent months, with three of nine Monetary Policy Committee members voting to increase rates at the December meeting, and several warning markets against engaging in a premature loosening in financial conditions.

But we suspect the easing timetable has been moved up, with rates likely to begin coming down quickly by the March policy meeting. Current market pricing – which implies five reductions in 2024 – could prove relatively durable as inflation falls and underlying economic growth remains moribund.

Implied policy rate by Bank of England meeting, %

A broad-based stabilization in fiscal governance and cross-Channel relations has lowered economic policy uncertainty levels in the UK over the last year, with both the “moron risk premium” and its Brexit-related equivalent beginning to evaporate in financial markets. In an effort to bolster popular support, Prime Minister Rishi Sunak’s government has pivoted toward cutting taxes and increasing spending – steps that are unlikely to alleviate price pressures, but might help put the economy on a better footing in the long term. And with a general election due to land before January 2025, opinion polls are pointing to a landslide victory for the opposition Labour Party, raising investor hopes for a gradual rapprochement with the EU.

UK-EU gap between Economic Policy Uncertainty Indices

Our outlook for the pound is bifurcated. As it becomes clear that post-pandemic price dynamics are not reflective of a post-Brexit structural break, and are instead simply lagging those seen on the Continent, we expect the exchange rate to fall in line with relative rate differentials. A pullback to sub-1.25 levels is not beyond the realm of possibility in the first quarter.

But in the longer term, we think underlying economic resilience could keep yield differentials surprisingly well supported. According to recent data revisions, the British economy managed to outperform both France and Germany through much of the post-pandemic period, and some measures of consumer and business sentiment are pointing to a modest re-acceleration in growth early in 2024. The deeply-unloved pound could steer a (bumpy and frequently-reversed) course above the 1.30 threshold against the dollar as it sheds some of the negativity that has become embedded in valuations over the last few years.

Estimated GBPUSD Expiration Range by Confidence Interval