PoundSterlingLIVE - "If that doesn't happen then watch out as we could be in for another round of Liz Truss style pain" - Jefferies.
The Pound to Dollar exchange rate fended off a rallying greenback to hold around 1.27 in the final session of the week but the inflation problem and risk of recession at the hands of the Bank of England (BoE) could limit its rise and may even invite fresh losses in the near future.
Dollars were bought widely on Friday alongside government bonds while stock markets and prices of some commodities fell but losses for Sterling were limited in depth while the Pound managed to edge higher against many other major counterparts following a mixed bag of economic figures from the UK.
"The UK’s poor growth/inflation trade-off is plain to see. The pound is a winner against the euro this morning because the Eurozone PMI data were, as my colleague Anatoli Annenkov put it this morning, ‘lousy,’" says Kit Juckes, chief FX strategist at Societe Generale (EPA:SOGN).
S&P Global surveys suggested activity in the breadwinning services sector reached three-month lows in June on Friday while the manufacturing industry was said to have fallen deeper into an earlier reported recession amid "subdued underlying demand and a headwind from customer destocking."
But there were also details of further high price increases and resilient employment levels, both being things the Bank of England is monitoring for reasons relating to inflation, while retail sales came in stronger than was expected by economists for the month of May.
"The prospect of further BoE rate hikes raises the risk of a deeper and/or longer UK recession. Recession concerns may be behind the weakness in GBP/USD despite the sharp positive BoE repricing," says Carol Kong, an economist and currency strategist at Commonwealth Bank of Australia.
The PMI surveys and retail sales data follow a BoE decision to raise Bank Rate from 4.5% to 5% on Thursday and are unlikely to have done anything to discourage the financial markets from continuing to bet on interest rates rising much further later on in the year.
"S&P’s survey continues to give an ambiguous steer on whether the MPC already has done enough to cool the economy and curb CPI inflation," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.
"While the composite PMI is consistent with quarter-on-quarter growth in GDP in Q2 of about 0.2%, it excludes the construction and public sectors in which output likely fell sharply in Q2. We still expect Q2 GDP to be broadly unchanged from Q1," he adds.
Some financial prices now suggest interest rates could top 6% by early next year after inflation and wage growth metrics came in stronger than economist forecasts this month.
"In the United Kingdom, the market path implied that Bank Rate would be around 4.8% following this meeting, and would now average around 5½% over the next three years, compared to just over 4% in the conditioning assumption underpinning the May Monetary Policy Report," the BoE said on Thursday.
"Recent data releases had been accompanied by larger movements in the OIS curve than surprises of a similar magnitude had generated previously, notably in response to the material upside surprises in recent UK data releases on CPI inflation and the labour market," it added.
This has dragged mortgage rates higher already while intensifying pressure on households and the broader economy in recent weeks, which is one more reason why Friday's PMI surveys might not be the last downbeat piece of data to emerge from the UK.
UK mortgage rates are more closely aligned with the interest rate swap market than they are with Bank Rate so the BoE policy stance is actually 'tighter' than commonly appreciated.
"The BoE and the UK economy and GBP longs for that matter, are all hanging their hat on a big drop in inflation for July. I keep hearing that call from economists around the street, that base effects are going to cause a big drop in July and finally take the pressure off of the BoE," says Brad Bechtel, global head of FX at Jefferies.
"If that doesn't happen then watch out as we could be in for another round of Liz Truss style pain. I went short the GBP/USD on the notion that it has no business being up here regardless of what happens on rates," he adds in Friday market commentary.
An original version of this article can be viewed at Pound Sterling Live
