Pound-Dollar Forecast "to Grind its Way Towards 1.42"

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• GBP/USD spot rate at time of writing: 1.4123
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With political considerations now largely out of the way, investors have been able to focus fully on the Bank of England's seemingly bullish outlook for the UK economy and have purchased the British Pound.

This is the message from a number of foreign exchange analysts we follow who note that the Pound's gains at the start of the week are in fact a delayed reaction to the previous Thursday's Bank of England (BoE) event.

The Pound-to-Dollar exchange rate (GBP/USD) advanced by over a percent on Monday and recorded a high at 1.4159 and is at 1.4127 on Tuesday, levels last seen in late February.

"We read the move as more of a legacy as the market is moving towards the Bank of England's bullish set of UK forecasts," says Chris Turner, Global Head of Markets and Regional Head of Research for UK & CEE at ING.

"Cable finally broke through 1.40 in Asia and deservedly so. We doubt the move can be attributed to the local or Scottish election results - these were reasonably well known and, with the Greens, the Scottish SNP will have a majority for pushing for another referendum," says Turner.

Turner says the market is moving towards the Bank of England's bullish set of UK forecasts and now greater confidence in the soft dollar environment.

The BoE's economic forecasts show the UK economy will now recover to pre-Covid levels in 2021, having undergone the sharpest increase in annual growth since 1947, a sharp improvement on previous expectations.

The BoE projects GDP growth in 2021 will be 7.25%, which is a material increase on the 5.0% projected in February, with economists at the Bank saying the improvement is down to progress on vaccinations and Government fiscal support.

The BoE now thinks the unemployment rate will peak at 5.4% in the third quarter of 2021, rather than the 7.8% forecast previously.

Given the BoE's much improved expectations for the UK economy ING now expect GBP/USD "to grind its way towards 1.4200/4250".

Foreign exchange analysts have meanwhile been of the view last week's local and regional elections gave investors reason to hold back on buying the Pound, particularly given concerns that a strong showing by the Scottish National Party (SNP) might prompt a constitutional showdown between the devolved Scottish administration and Westminster over the holding of a second independence referendum.

The narrative heading into the Thursday vote was that a SNP majority would in effect provide a strong mandated for the holding of another vote.

But, given the SNP's failure to reach a majority analysts view the path towards another referendum is decidedly more difficult and that it might only happen in a number of years.

"Pro-independence parties would need to swiftly iron out divergences that led them to campaign separately in the first place. The complexity of Scottish independence means that members of such a pro-independence alliance would almost certainly differ regarding practical implementation, possibly weakening the case for independence," says Fabrice Montagné, an economist with Barclays.

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For foreign exchange market participants the political landscape on Monday is less threatening than it was days earlier, allowing investors to focus more fully on the positive UK economic backdrop and the recent BoE guidance.

"Upbeat GBP sentiment comes as Scotland’s SNP fell one seat short of a parliamentary majority in last Thursday’s elections—which may also have delayed bigger gains for the GBP after the BoE’s announcement that are now developing as election worries fade," says Shaun Osborne, FX Strategist at Scotiabank.

The SNP will form a government with the help of the Greens whose eight seats will allow the coalition to govern effectively.

SNP leader Nicola Sturgeon has meanwhile said she will only guide her government towards holding a referendum once the covid-19 pandemic had been dealt with.

"An independence referendum remains a key risk for the GBP, but its impact will likely not be felt until a legislative push for IndyRef2—and a clash between Holyrood and Westminster. We think that over the near-term trading horizon, the pound should extend its gains as economic data show a strong post-lockdown recovery," says Osborne.

Scotiabank says having firmly broken through the 1.40 ceiling of its March to early May trading band, GBP/USD will next seek to firmly break above 1.41.

"The 1.42 level stands as the next clear mark on the charts as resistance while its push against its upper Bollinger may check its strong bounce off 1.39—while nearing overbought on the RSI," says Osborne.