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An interesting take on pound sterling's prospects heading into this week's inflation data print.
Strategists at the investment bank think a soft inflation print might actually be to the pound's benefit.
"We see September CPI coming in softer than expected, potentially boosting GBP if long-end gilt yields ease," say strategists in a new note, released Monday.
The suggestion flies in the face of conventional thinking that says a currency tends to appreciate in response to higher inflation levels, as it implies higher interest rates at the central bank as it seeks to limit inflation's rise. Those higher interest rates meanwhile attract foreign investor flows, which boosts the currency in return.
However, that is an orthodoxy that has been built in a low-inflation, low-interest-rate world, which we became accustomed to in the decade and a half since the 2008 financial crisis.
Now, we are in a new epoch of high inflation and high interest rates, and the assumption that high inflation is good for a currency is being tested.
Certainly, if high inflation were a leader of currency outperformance, the pound would be sitting atop the performance board for 2025. The UK's inflation rate for September is expected to be at 4.0%, far higher than in the U.S., Eurozone and comparable economies.
Image courtesy of economist Julian Jessop.
Despite this dubious distinction, the pound is putting in a distinctly mediocre performance this year, confirming that high inflation is no harbinger of currency strength.
"Softer-than-expected core inflation (particularly services, which we also expect to be slower than widely forecast) may lead to GBP outperformance this week, given the recent negative correlation between long-end gilt yields and GBP," says Morgan Stanley.
Strategists at the investment bank hold a 'bullish' stance on the pound.
"Solid UK capex and productivity trends, plus crowded EUR/GBP longs, should keep GBP supported," says Morgan Stanley.