Pound to Dollar Week Ahead Forecast: Outlook Hanging in Balance

• GBP/USD supported near 1.2627 on charts short-term
• Straddling middle of 1.2015 to 13353 ‘fair value’ range
• U.S. CPI & UK’s GDP potential pitfalls for any recovery 

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The Pound to Dollar exchange rate entered the new week finely balanced around the middle of its medium-term equilibrium range spanning the gap between 1.20 and 1.33 but  with short-term prospects hinged on market appetite for ‘carry’ trades and UK economic growth numbers out on Friday. 

Sterling entered the new week with almost a month’s worth of losses against a broadly stronger Dollar in tow but could benefit in the days ahead from technical support nearby around 1.2627 on the charts, which was tried and tested in the sell-off that followed last Thursday’s Bank of England (BoE) interest rate decision.

But with the Pound to Dollar rate already having reversed more than 50% of its second quarter rally over the course of July, price action over the coming days will be a key determinant of whether the broader recovery from last year’s record low still has further to run, or if a deeper setback is in the pipeline.

“UK/US spreads have narrowed from the peaks seen in early July but remain GBP-positive, which should help,” writes Shaun Osborne, chief FX strategist at Scotiabank.

“Intraday price action has turned a little weaker again, with GBP gains capped at 1.2745, which will be disappointing for GBP bulls,” he adds in a Friday market commentary. 

Above: Pound to Dollar rate shown at daily intervals with selected moving averages and Fibonacci retracements of selected uptrends indicating possible areas of technical support for Sterling. 

The Pound-Dollar rally of recent months has been aided by a significant increase in the Bank of England Bank Rate, which raised to 5.25% last week in a policy decision making UK borrowing costs the second highest in the G10 universe after the U.S. while likely cementing in place Sterling’s appeal as a ‘carry trade’ candidate.

North American and European bank analysts have been some of the most enthusiastic advocates of buying Sterling in recent months, though the Pound to Dollar rate’s sharp correction from levels above 1.30 in mid-July may have left it at something of a trend inflection point on the charts. 

“The 100dma comes in around 1.2585 and a break there opens a move to the 200dma around 1.2317 which is also the range low of the uptrend channel this pair has been in all year,” says Brad Bechtel, global head of FX at Jefferies, in a Friday market commentary.

“Not sure we'll get enough today to test those levels and this pair might consolidate a bit higher after the recent sell off from July 14 when everyone shifted bearish the USD. If we do get any moves higher I would sell them as I think GBP/USD will indeed test the 200dma around 1.2317 in coming weeks,” he adds. 

Recent losses have left the Pound sitting almost exactly at the midpoint of its current medium-term equilibrium or ‘fair value’ range, which spans the distance between 1.2015 and 1.3353 when the GBP/USD pair is discounted for previous and present inflation rates, interest rates and their respective differentials.   

But how the Pound-Dollar trend develops from here will depend in large part on whether economists have underestimated the anticipated July rebound in U.S. inflation, the latest reading of which is out on Thursday, and on how the UK economy fares in the face of forecasters’ expectations on Friday. 

Above: Real and nominal equilibrium or ‘fair value’ estimates for selected pairs. Source: Pound Sterling Live. Click for more detailed inspection. 

“We expect both headline and core CPI inflation to rise by 0.2% m/m in July,” says Tom Kenny, a senior economist at ANZ. 

The economist consensus is for the annual U.S. inflation rate to rise from 3% to 3.3% for July on Thursday, which would be its first acceleration for more than a year, while the more important core inflation rate is expected to fall from 4.8% to only 4.7% for last month. 

While the Federal Reserve has already signaled that an end to its interest rate cycle is near and the bar is set high for it to raise borrowing costs further, the U.S. Dollar has tended to rise in response to higher-than-expected inflation so Thursday’s data would be a possible pitfall for Sterling in the event of any rebound beforehand.

The Pound to Dollar rate also risks being hamstrung further ahead of the weekend if Friday’s release of UK GDP data for June and the second quarter challenged market optimism about the outlook for the UK economy and prospect of further increases in the Bank of England Bank Rate over the coming months. 

“Markets have come a long way towards our view over the past month but are still pricing in two further 25bp hikes, in September and November. We wouldn’t rule out that scenario, but the near-term outlook for the macro data suggests the greater risk to our forecast is that the MPC simply maintains Bank Rate at 5.25%,” says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

Above: Quantitative model estimates of possible ranges for week ahead. Source: Pound Sterling Live.