Last week, GBP/USD managed to bounce off its 2-year low. The pair surged upwards early on Monday as well. However, its prospects remain bleak.
At the beginning of Monday's session, GBP/USD increased by 0.2% and reached 1.2650.
If GBP/USD manages to break above last week's high of 1.2667, it could then reach 1.2700 in the near future.
However, the pair's short-term upturn is driven solely by a weakening of the USD dollar. It is unlikely to last long.
The US dollar index has decreased amid falling demand for safe-haven USD and optimism in the stock market.
Relaxed quarantine restrictions in China have boosted risk appetite among investors, who were anxious about the possible global economic slowdown.
However, recession risks for the UK economy remain very high.
Inflation in the UK, which surpassed 9% in April, leaves the Bank of England no choice but to hike interest rates by 50 basis points at its next meeting.
While a sharp rate increase could push GBP upwards, it could also backfire on economic growth and weigh down on the pound sterling.
Nevertheless, market players expect that BoE policymakers would not be deterred by recession risks. The UK central bank will likely strive to regain its authority, which was questioned by the UK parliament recently. MPs have criticized the regulator's anti-inflationary policies.
During its recent monetary tightening cycle, which began in December 2021, the Bank of England increased interest rates 4 times. However, some MPs stated the central bank was not hawkish enough.
Alternatively, the Bank of England could abstain from increasing the interest rate by 0.5% in June, given the notable fall in UK consumer sentiment.
At the end of last week, the UK government set out a £15 billion ($19 billion) support package to help households struggling with rising energy costs.
However, these measures are unlikely to improve consumer sentiment in the near future, economists say.
The market is currently pricing in five 25 basis point rate hikes by the end of the year. Market players also expect inflation to rise even further from its current 40-year high.
The dovish position of the BoE amid high inflationary pressure could send the pound sterling downwards in the medium term.
GBP is likely to continue to fall against USD, no matter what policy course the UK regulator takes.Since the beginning of the year, GBP/USD lost 7%. In May, the pair fell to 1.20, the lowest level since 2020.
GBP/USD could retreat back to this level or sink even lower.
GBP/EUR could also slump, as the European Central Bank is getting ready for its first interest rate hike in years. The pound sterling will likely fall once the decision is made.
In its recent outlook, Deutsche Bank AG strategists recommended clients buy euros, pointing to a target of 88 pence by the end of the third quarter. It was at about 85 pence on Friday, May 27.
