Currency analysts at MUFG believe sterling’s outlook for 2023 is more constructive, and cite several reasons for increased confidence.

The bank expects some recovery in political confidence to support sentiment, while lower gas prices will help improve the fiscal position.

The bank is also optimistic that improved relations with the EU have brought a deal on the Northern Ireland protocol closer.

In this context, the bank sees an opportunity for leveraged funds to go long sterling, which will support the currency.

MUFG still expects the Pound to Dollar (GBP/USD) exchange rate to be subject to further short-term dips, potentially falling to below 1.15 as the Dollar recovers. However, GBP/USD is forecast to resume rising to 1.30 in late 2023, with gains driven by renewed dollar losses and a limited recovery in the pound.

Recalibrating the political and fiscal outlook

MUFG expects the UK’s political outlook to be more stable in 2023, and the bank believes that improved political confidence will lead to increased confidence in the fiscal outlook.

The bank also believes that energy price developments will be important for government spending.

The bank notes: “Moreover, the drop in natural gas prices, if sustained, will significantly increase confidence in the budget. Even if we see a recovery in gas prices, the overall value of the energy price guarantee appears likely to be less than OBR has assumed.”

Improving relations with the EU

An important aspect of the new UK administration is that relations with the EU have improved, with both sides tending to back away from an antagonistic stance on the Northern Ireland protocol.

MUFG notes that both sides have reached an agreement to share data on goods tracked in Northern Ireland.

The rhetoric from Irish political leaders has also improved, with Foreign Minister Martin saying this is an important building block for a potential agreement.

There were hopes that an agreement could be reached by the 25th anniversary of the Good Friday Agreement in April.

According to MUFG: “Regardless of whether that deadline is reached, we still see a new approach here and the improved UK-EU relationship is a clear positive for the pound compared to what it has been in previous years.”

Funds are less pessimistic about sterling

MUFG also notes that there has been a shift in the positioning of global funds and traders. The bank notes that there have been very limited periods when compound positioning has been positive for sterling with long positions, but recent data suggests this could happen again.

According to MUFG, “Since the run-up to and after the Brexit referendum, there have been very few periods when asset managers’ positioning and leverage combined have been net long the pound. When this has happened, these periods have coincided with a rise in sterling. We are currently close to moving to a net long pound position.”