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"Out of Whack" - Is the Pound Dollar Exchange Rate Due a Rebound?

US dollar to pound sterling exchange rate

A look at the latest forecasts for the pound dollar exchange rate from analysts at BMO Capital, UBS and Natixis.

"The only two currency moves that seem somewhat out-of-whack are the declines in GBP and JPY," notes Greg Anderson at BMO Capital in reference to the recent declines in sterling and the yen.

However, USD strength should ultimately ease back as we head into the year-end suggests Anderson. However, BMO join Natixis and Swissquote Bank in seeing further USD strength in 2015 suggesting that while the short-term could see a GBP relief rally, the longer-term picture favours the buck.

  • At the time of writing we see the pound to dollar exchange rate (GBP/USD) is 0.04 pct higher on a day-by-day comparison at 1.5676.
  • The euro to dollar exchange rate (EUR/USD) is meanwhile 0.22 pct lower at 1.2527.

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GBP was recently knocked lower by the BoE’s release of an unexpectedly dovish Quarterly Inflation Report which shows us the front end of the UK gilt curve was pricing in too many rate hikes and were pricing them too early.

Sterling and interest rate expectations have had to fall back as markets re-adjust.

Driving a wedge between GBP and USD is the observation that the US Federal Reserve would probably hike before the Bank of England because the US economy was built on stronger foundations.

"Given the natural softening in UK data trends of late, following strong growth in the first half of the year, we expect to see the first rate rise in 2015 in both the UK and US – a few months ago the UK market was pricing in a rate rise in November, 2014! The market is now priced for the Federal Reserve to raise rates before the BoE, which we believe is fair," says David Absolon, Investment Director at Heartwood Investment Management.

Boost for Sterling as Bank of England Decision Makers Disagree

The MPC minutes provided some relief to the under-fire GBP after they revealed a more balanced assessment compared to the QIR.

In particular, for some of the members voting to leave rates unchanged, they saw “risk that the degree of spare capacity would be eliminated more quickly than assumed in the November Report’s central projections” pointing to upside risks to the inflation forecast implied by market rates.

"Rate hike expectations were pushed back post-QIR, but this statement in the minutes confirms our view that the re-pricing was somewhat exaggerated. While the short-end of the UK curve has steepened slightly after the minutes, market pricing for the first rate hike remains at Nov-2015. We see potential for a further recovery in GBP as rate hike expectations get brought forward. Focus will shift to the UK retail sales today, an upside surprise could trigger a further recovery in GBP," say Lloyds Bank Research in a note to clients.

GBP/USD Could Find a Bottom Ahead of the Year-End

IMM leveraged funds are net long the USD by USD 33bn, which is the third biggest net USD position (on either side) over the past five years.

In simple terms this tells us that investors have taken extensive bets that the USD will rise further, the implication here is that the market could literally struggle to find more buyers, and thus the USD's potential to rally is limited.

"The room for additional USD longs is probably becoming limited. We don’t expect a major reversal, but we continue to think the USD rally will fade in to a range until year-end," says BMO's Anderson.

BMO Capital expect the USD rally to resume in January when market focus will quickly turn to the Fed removing ‘considerable period’ from its Statement.

Strong Gains for the Dollar in 2015

We hear from UBS that they are bullish on the dollar moving forward:

"We concur with the consensus view that the dollar will enjoy healthy gains in 2015 and beyond, but the path is potentially dynamic given that dollar strength could yield both benign and disruptive outcomes, depending on what's driving it.

"Despite pledges by the Fed to back-load normalisation, and a general lack of tail risks, uncertainty discounts are set to increase for exposed currencies."

Natixis add to the pro-USD viewpoint:

"There is nothing standing in the way of a monetary tightening by the Federal Reserve come mid-2015. The US 2-year rate is back at its highest levels of September at 0.54%, and can be expected to extend its rise. And although the US 10-year rate has also risen, it is only at 2.40%, which is 20bp below its September high," Natixis adds.

"In short, the overall environment remains favourable for the US dollar. That can be seen in the significant positions held by speculative accounts, to the point in fact when the currency is starting to be overbought. The DXY dollar index has broken above 88 and we see it appreciating further to 90-91 in coming months," Natixis projects."

Swissquote take a look at the nearer-term dynamics in the pound dollar exchange rate:

"GBP/USD's bounce has thus far been unimpressive. Hourly resistances can be found at 1.5736 (17/11/2014 high) and 1.5781 (13/11/2014 high). An hourly support lies at 1.5593 (14/11/2014 low).

"In the longer term, the break of the support at 1.5855 (12/11/2013 low) confirms an underlying bearish trend. A conservative downside risk is given by a test of the support at 1.5423 (14/08/2013 low). Another support can be found at 1.5102 (02/08/2013 low).

"A key resistance lies at 1.6038 (30/10/2014 high, see also the declining channel)."

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