Sterling Is the Best Performing G-10 Currency This Year, and Strategists Remain Cautiously Optimistic

The pound has gained more than 3% since the beginning of the year. It reached a new 10-month high in the last few days, thanks to better-than expected economic data, and a weaker dollar.

The major economic forecasters now have upgraded their outlooks.

LONDON - The

British pound

The pound is expected to be the best-performing currency in the G-10 (Group of Ten currencies) by 2023. Some strategists think that the pound will continue its upward trend over the medium term.

The sterling is up more than 3% versus the

dollar

Since the beginning of the year, the dollar has been weakening and the economic data have exceeded expectations.

Around 11:30 am London time, the pound was trading at $1.2455. The currency has recovered spectacularly since the

Record lows in September

, after former Prime Minister Liz Truss' disastrous "mini-budget."

Deutsche Bank

The market was too short of sterling in 2023, due to the excessively pessimistic sentiment fuelled by the bleak predictions of the IMF and the Bank of England, as well as the Office for Budget Responsibility of the U.K., which all predicted long recessions.

The major economic forecasters' outlooks have been upgraded. For example, the OBR is no longer predicting a technical contraction in 2023 -- defined as two quarters of negative GDP.

Gas prices have dropped sharply, which has helped to improve the country's financial position.

Additional fiscal support by the Government

Positive sentiment has grown in recent years.

But the picture still isn't entirely rosy. The U.K. is the only G-7 economy that has not recovered to its pre-Covid output level.

Inflation is still hovering around double digits

British households are still struggling with high energy and food bills.

Recent mass strikes have been launched

There are disputes about conditions and pay.

As policymakers struggled to deal with persistently high prices, the Bank of England raised interest rates by 25 basis point. This is their highest rate since 2008. Markets are pricing in a 63% probability of another quarter-point increase at the Bank meeting in May.

The risks are skewed upwards

Deutsche Bank called it that at the beginning of the year

Cable

In a note published on Wednesday, FX Strategist Shreyas gopal said that the projection was almost met. "Most of the good news for the U.K. is likely to be in the price."

Gopal stated that "the market has agreed with our view of UK growth expectations being upgraded to match other major economies this year. However, our house view remains more optimistic than the consensus," he said.

"In micro, the movement in the currency during the past month appears to be a little overdone when compared with relative rates performance. With the added kicker, the market is mostly pricing another hike from the BoE at its May meeting, but our base scenario is for a holding."

Gopal said that real rate differentials might offer cable a medium-term advantage, as it has been "dislocated" and "too cheap" for nearly a year.

Gopal stated that the pound could be one of the relative winners if private sector leverage was the main differentiator in the rest of the cycle.

Gopal added that the improved data on the current account, which is due to the lower gas prices in the UK and the concentration of foreign direct investments in the energy sector, could also be supportive.

"The good news for Cable is now in the price. But given the external background, our Cable forecasts still have a higher risk," he said. Deutsche recommends that investors remain long the pound both against the U.S. Dollar and Swedish Krona.

The strongest of the weak

The traditional safe-haven currency, the U.S. Dollar, has been weakened significantly. In the last six months, the DXY U.S. Dollar currency index is down by more than 9%.

Ray Attrill is the head of FX Strategy at the Fixed Income, Currencies and Commodities Division of National Australia Bank. He told CNBC’s “Street Signs Asia” on Wednesday that greenback has become "extremely overvalued", and the Japanese yen and British pounds are the most "undervalued".

He suggested that although the good news of recent months has been priced in sterling's recent jump from $1.19 up to $1.25 within a short period, these two currencies will benefit from the "correction'' of the dollar over the medium-term.

If you look at the situation from a purchasing power parity or other real exchange rate argument perspective, the yen and sterling are the two weakest currencies. On that basis, If the U.S. Dollar is going to continue heading south, they would probably be the two in terms of G-10 that have the most potential upside here," Attrill stated.

Fundamentals are not enough to'strongly believe'

Not everyone is so sure. Valentin Marinov is the head of G-10 research at Credit Agricole CIB. He told CNBC that, despite the fact that the data have been surprisingly resilient in recent months, the outlook for Britain's economy "is still not that good, even relative terms."

Marinov stated that "it certainly helps that other economies, like the U.S., have seen their outlooks deteriorate quite rapidly. So that is helping to the pound. But I wouldn't believe that the pound was a strong buy solely on the basis domestic fundamentals."

He also pointed out that historically, sterling was among the worst performing currencies during the early stages of recessions, dating back to 1980. With global growth concerns continuing as central banks continue raising interest rates, the British pound is not the best bet at the moment.

He said: "At the current levels, this is a remarkable performance that goes against our forecasts. But I don't believe that it will continue to be a sustained uptrend. I would prefer to sell cable here."

"Euro-sterling appears to be more reasonably priced but again, it's about how far the continental European outlook can deteriorate before reverting back to the low benchmark the U.K. still represents."