Pound to Dollar: Beware Dips into 1.16/18 Area

"A more modest 25bp hike on March 23rd could prove some downside risks to GBP/USD - perhaps to the 1.16/18 area" - ING.

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The British Pound is now down on the Dollar for 2023 thanks to the sizeable retreat witnessed in February, and some analysts say further falls well sub-1.20 are possible over the coming weeks.

Research from ING Bank shows the Pound to Dollar exchange rate (GBP/USD) could in fact fall to fresh four-month lows over the duration of March, but a more sustainable recovery into year-end can still be expected.

This assessment comes after the Dollar rebounded in February as investors recognised the Federal Reserve would need to raise interest rates by a greater degree than they had expected at the start of the year.

"We are in the camp that the Fed will hike more than most investors think, which could sustain support for the dollar," says Bilal Hafeez, Head of Research at Macro Hive.

The Pound to Dollar exchange rate (GBP/USD) is now down for 2023 having fallen 2.45% in February in a move that reversed January's 1.87% advance.

The Dollar found favour again following a string of U.S. economic reports that revealed the economy was strong enough to continue generating above-target inflation levels, warranting further interest rate hikes at the Fed.

Data remains in the driving seat and key near-term events that could spike Dollar volatility include the March 22 Federal Reserve rate decision, U.S. payrolls on March 10 and CPI inflation on March 14.

Above-consensus readings could embolden Dollar bulls; likewise, softer-than-expected readings could penalise the Greenback, offering GBP/USD some near-term support.

"A return to a more measured pace of jobs growth, in line with what we and most other forecasters anticipate, would probably take some steam out of the dollar’s rebound," says Jonas Goltermann, Deputy Chief Markets Economist at Capital Economics.

If this prediction is correct, GBP/USD could find itself supported above 1.20 this week.

"The main focus will be US activity data and the FOMC meeting. On the former, the big question is whether the bounce in January US activity data (payrolls, retail sales etc) was largely weather and seasonal adjustment related," says Chris Turner, head of FX research at ING Bank.

ING's U.S. economist, James Knightley, thinks it was.

"Softer activity data could soften up the dollar a little this month," says Turner.

But, for ING's strategy team, March is too early to bet against the Federal Reserve and for a weaker Dollar.

"Tighter central bank policies into slowing economies are keeping yield curves exceptionally inverted and only increasing the risk of a correction in the equity or credit space. This is hardly the environment for the kind of benign dollar decline seen towards the tail-end of last year," says Turner.

Any Dollar weakness triggered by this week's data readings could therefore prove relatively short-lived.

Above: GBP/USD's late-2022 rebound has stalled. Consider setting a free FX rate alert here to better time your payment requirements.

The Bank of England is meanwhile said by analysts to be much closer to a pause in its interest rate hiking cycle than the Fed or the ECB, which could in turn prompt weakness in the Pound.

"Given our expectation for the BoE to ultimately disappoint current market
pricing following the March meeting, we see this as a dynamic that continues to weigh on the pound over coming months," says Simon Harvey, Head of Research at Monex.

Bank of England Governor Andrew Bailey said in a speech last week that a March rate hike was not guaranteed, suggesting the Bank was closer to a pause than markets are expecting.

"A more modest 25bp hike on March 23rd could prove some downside risks to GBP/USD - perhaps to the 1.16/18 area," says Turner.

But, the exchange rate would likely recover into year-end as the Dollar still looks to weaken more broadly by the majority of analysts we follow.

"In terms of the bigger picture, we still look for lower dollar levels by the end of the year. US disinflation should be a lot more evident by this summer and a Fed easing policy by year-end should see some bullish disinversion of the US yield curve and a broadly weaker dollar," says Turner.

ING holds a year-end forecast for GBP/USD at 1.24.