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The Pound-Dollar Week Ahead: Charts and BoE Pricing Point Higher but Global Environment a Risk

- GBP/USD charts and BoE expectations point higher.

- GBP return toward December high possible this week.

- And downside is limited near 1.29, Commerzbank says.

- Fundamental downside also limited, upside is building.

- After market almost fully prices BoE rate cut Thursday.

- USD eyes Fed decision, Q4 GDP data and coronavirus.

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- GBP/USD Spot rate: 1.3066, down 0.40% Friday

- Indicative bank rates for transfers: 1.2725-1.2817

- Transfer specialist indicative rates: 1.2887-1.2965 >> Get your quote now

The Pound closed the Friday session having become the second best performing major currency of the week although there could be further gains in store for the coming days if studies of the charts and the market's evolving view on the Bank of England (BoE) outlook are anything to go by.

Sterling was one of only two major currencies to get the better of the Dollar last week after economic data led markets to rethink their expectations of Thursday's interest rate decision from the BoE. It closed the week with a 0.49% gain over the greenback even after having declined 0.40% on Friday.

"Newsflow surrounding the coronavirus might keep sentiment on edge," says Mark McCormick, head of FX strategy at TD Securities. "Our focus shifts to the EUR and GBP. Eurozone HICP will garner more interest following the ECB's slightly more constructive sentiment on underlying inflation dynamics. Meanwhile, the BOE meeting appears to be a close call following better PMI prints. Despite this, we maintain our call for a cut and expect GBP to underperform vs. USD and EUR."

Market pricing still implies that a rate cut is likely, albeit to a lesser extent than at the beginning of last week, so Thursday's decision could well be a source of gains for Sterling. But upside potential doesn't come only from the fundamental side because the charts are also pointing higher.

Technical analysts at Commerzbank say Sterling will retain an upside bias so long as the Pound-to-Dollar rate holds above the 1.2884-to-1.2908 areas, although they've also warned that a break below there would augur more losses.

Above: Pound-to-Dollar rate shown at hourly intervals.

"GBP/USD held steady holding on to recent gains and we will assume that there is scope for a deeper recovery to the 1.3285 Fibonacci retracement,"  says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank."Fibonacci resistance at 1.3285 is considered to be the last defence for the December high at 1.3515." 

Jones says the market should remain underpinned by an upward sloping trendline that coincides with the 1.2884 level but has warned that move below there would invite a deeper sell-off back toward 1.2689.

She's advocated that Commerzbank clients bet on an increase in the Pound-to-Dollar rate from the 1.3055 and 1.3095 levels, but also suggested they walk away from those bets if the market dips below 1.3020.

The Pound-to-Dollar pair spent the period between April 2018 and October 2019 mired in a downtrend but overcame a key downward sloping trendline in mid-October when Prime Minister Boris Johnson declared victory in his attempt to renegotiate aspects of Theresa May's EU withdrawal agreement. 

Overcoming the downtrend led Sterling straight into an earlier symmetric triangle continuation pattern that resolved to the upside when it emerged Boris Johnson was on course for a landslide election win back in December.

The resulting move higher took the Pound-Dollar rate up toward 1.35 although since mid-December the exchange rate appears to have been consolidating within another symmetric triangle which, according to conventional thinking, should also resolve to the upside.

Above: Pound-to-Dollar rate shown at daily intervals.

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Pound Sterling: What to Watch 

The Pound was the second best performing currency for the week by the Friday close but could go on to extend gains over the coming days if the Bank of England refrains from cutting interest rates Thursday. 

Sterling was soft last week before strengthening from Tuesday after December's jobs and wages data surprised on the upside, giving investors cause to pare back some of their earlier bearish bets on the British currency ahead of this Thursday's eagerly-awaited decision from the BoE. That move was aided Friday by IHS Markit PMI surveys that pointed to a stronger-than-expected uptick in services and manufacturing activity for January.

Brexit Day on Friday, 31 January will doubtlessly garner many column inches in the week ahead although the date will mark an EU exit that wholly technical and legalistic in nature so will matter little for the immediate prospects of Pound Sterling. Price action in the UK currency will instead be determined by speculation ahead of Thursday's interest rate decision from the BoE.

The consensus among economists and analysts is for the Bank of England to leave Bank Rate unchanged at 0.75% at 12:00 Thursday although that view is in now way reflected by pricing in the financial markets, with pricing in the overnight-index-swap (OIS) market implying on Friday morning a January 30 Bank Rate of just 0.55%. Market pricing implies around an 80% probability of a rate cut this week but economists say it won't happen and only one can be right.

"Hard UK macro data such as retail sales and GDP have made it clear that the economy had a dismal fourth quarter, in large part due to political uncertainty from the general election and the risk of a no-deal Brexit," says Ranko Berich, head of market analysis at Monex Europe. "The MPC must balance the significant slowdown in growth seen in Q4 against the probable recovery that currently appears to be happening."

BoE Governor Mark Carney and various other Monetary Policy Committee members said earlier this month they'd vote for a rate cut Thursday if they did not see signs of improvement in the New Year economy before then. So Friday's PMI data could excuse the BoE for eschewing a rate cut this week but the surveys have often proven to be unreliable indicators during times of political uncertainty and the bank itself was bitten for having put faith in them in the immediate aftermath of the referendum.

Furthermore, Thursday's meeting marks the final outing of Governor Mark Carney as chair of the MPC because he's set to depart the bank on March 16, and so his last opportunity to engineer a rethink of the MPC's long-held contention that interest rates will need to rise from current levels over the coming years in order to keep inflation in check. That idea explains why the BoE has left bank rate unchanged since August 2018 despite most other comparable central banks having cut rates.

"Our economists expect the bank to err on the side of caution and to remain on hold," says Chris Turner, head of FX strategy at ING. "The scale of the GBP upside may not be pronounced as the uncertainty about the UK economic data and the tightest voting margin behind the BoE decision not to cut rates suggest that the market will continue pricing a non-negligible probability of a cut in coming months. So the market will postpone the expectations of the cut rather than fully reverse it."

Carney and colleagues have argued higher rates will be necessary because the Brexit vote has reduced the UK's growth 'potential' and left the economy more susceptible to inflation, despite the consumer price index having been in decline since November 2017 when it was recorded at 3.1%. Inflation was just 1.3% in December, far below the BoE's 2% target, while the economy is growing beneath its 'potential' or inflation-producing rate of expansion.

Given current market pricing any rate cut may deliver only limited downside to Sterling unless the BoE hints that further cuts could follow in the coming months. And given the bank may yet decide to eschew a cut, the potential upside could be greater than the downside this week. 

However, international factors will also be in the mix and could see other currencies advance on Sterling. Notably, Eurozone growth and inflation figures as well as the January Federal Reserve (Fedrate decision. 

Pound Sterling Live previously reported that there would be an autumn forecast statement on Wednesday 29, January. This resulted in part from an error made by a third party data provider. The budget will not be released until March 11.

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The Dollar: What to Watch

The Dollar gained over most rivals last week after benefiting from a hunt for yield in financial markets and fears over the spread of China's new coronavirus and although these factors will remain front and centre for investors in the days ahead, the current condition of the U.S. economy will also demand attention too.

New economic data has been thin on the ground in the U.S. of late although the same cannot be said this week because the current condition of the economy will be brought back to the fore by Wednesday's 19:00 interest rate decision from the Federal Reserve and final quarter GDP data. Consensus is for the Fed to leave its interest rate unchanged at 1.75% so it'll be the accompanying statement that garners the bulk of the market's attention instead. 

Investors will take their cues from any changes to the Fed's assesment of the jobs market as well as domestic and global economies because the bank has made all of those key to its future interest rates decisions. And on each of those scores, the latest information supports arguments in favour of an unchanged interest rate stance and guidance for more 'data dependent' sitting-on-hands from Chairman Jerome Powell and the Federal Open Market Committee. 

"We do not expect any material change to balance sheet plans or in the key policy rate next week. The Fed is likely to maintain a cautious tone over the outlook for the US economy while acknowledging downside risks from trade have eased, says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

Any comments on the Fed's regular provision of 'liquidity' to the interbank financial system will also be scrutinised closely because its post-September re-expansion of its balance sheet has steadily increased the supply of Dollars on the market, which has the potential to be a headwind for the U.S. currency. 

Markets are betting the Fed delivers at least one further interest rate cut in 2020 although the bank itself has said it would require a "material change" of its outlook for steady GDP growth of around 2% in 2020, with near-target inflation and full employment in order to prompt any further policy action. And so far the economy appears to be delivering the Fed's forecasts on all of those scores.

"We are slightly below the consensus which could be bearish for the USD and bullish for fixed income," says Katherine Judge, an economist at CIBC Capital Markets. "Growth in the US economy appears to have slowed to just below potential at 1.8% in Q4, refl ecting a deceleration in consumer spending to a more sustainable pace, and a fall in business investment, concentrated in the structures component. Lower interest rates appear to have lifted residential investment, however, providing a partial offset."

U.S. GDP growth actually accelerated in the third quarter when it rose from an annualised 2%, to 2.1% and markets are looking for it to have risen further to 2.2% in the final quarter when year-end figures are released Thursday. 'Nowcasting' estimates from the Federal Reserve Bank of New York support the idea of such an uptick, with the growth rate implied by the weekly nowcasting reports having trended sideways at around 1.22% since late December. 

The New York Fed's nowcast suggested throughout October that GDP growth was likely to have declined in the third quarter, with highest estimate recorded during that month being just 1.3%, only for the actualy growth rate to have ticked slightly higher to 2.1%. And throughout this January the nowcast has been remarkably steady at around 1.22%, which may mean an upside surprise to the consensus could even be likely.  

"Better than expected economic data from the US and Germany since the start of this year has encouraged speculation that the global economy may be healing," says Jane Foley, a strategist at Rabobank. "While there may be further upside potential for risky assets in the near-term, it is our view that optimism will fizzle and burn away during the course of this year. Consequently, even though we expect the Fed to cut rates further this year, we expect that downside potential for the USD will be well contained.

The Dollar remains one of the highest yielding major currencies and given its dual role as a so-called safe-haven, it's well positioned to benefit not only from the possibly steady hand of the Fed, but also mounting concerns about the spread of China's new coronavirus. Those concerns made the safe-haven Japanese Yen the best performing major currency last week, with the Dollar in third place behind Pound Sterling. 

"As at 2400 hours on 25 January, the National Health and wellness board had received a cumulative report of 1975 confirmed cases in 30 provinces (districts, municipalities) and 324 existing severe cases.Cumulative deaths 56 cases, cumulative cured discharged 49 cases.There are 2684 suspected cases," says China's National Health Commission in a January 26 notice.

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