Pound-Dollar Rally Faces Central Bank Test This Week
- Written by: Gary Howes
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Pound sterling wants to go higher against the dollar, but two central bank decisions will have their say this week.
The pound-dollar exchange rate has been consolidating between 1.36 and 1.3480 for about ten days now, having rallied from lows at 1.3160 earlier in April.
We therefore think that the exchange rate is catching its breath after that strong recovery and, on balance, the rally should restart at some point in the near future.
Gains to 1.36 cannot be ruled out this week, but for a break above here, we would need some concerted selling of the dollar.
This week could be too soon for such an eventuality, meaning we're likely to see a random walk continue around current levels with dips finding support towards the 200-day moving average at 1.3389.
Holding the GBP/USD from making a more decisive advance will be the ongoing uncertainty regarding U.S. and Iran negotiations; the past weekend didn't deliver any fresh breakthroughs but the sides continue to talk about talking.
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A deal is wanted, and that's enough to keep the dollar on the defensive. However, we're discovering that a major impediment to progress is a lack of unity on the Iranian side. That could take some time to resolve, meaning we're likely to continue to see contradictory headline flow in the coming days. That should trigger moves in GBP/USD, but ultimately, nothing substantive is expected until some true signs of progress are made.
With war headlines losing their bite, the dollar and pound will can partake in the more traditional fare of central bank headlines:
The Federal Reserve updates rates and policy guidance on Wednesday and is expected to keep the federal funds target range at 3.50-3.75%.
🎯 GBP/USD year-ahead forecast: Consensus targets from our survey of over 30 investment bank projections. Request your copy.
Various speeches and interviews reveal Fed rate setters see the recent rise in inflation as a one‑off, with limited second‑round effects, meaning the higher energy costs aren't expected to trigger meaningful price rises elsewhere.
"The Fed still signals that the next move in rates is more likely to be a cut, though not in the near term," says a note from Lloyds Bank.
With markets expecting the Fed's next move to be a cut, but the Bank of England's to be a hike, there's an underlying divergence in policy that skews in favour of ongoing pound-dollar upside.
Downside risks for GBP/USD in the week ahead include Bank of England rate-cut bets cooling somewhat following Thursday's decision; currently, the market is poised for two rate hikes, something many economists think is pie-in-the-sky thinking.
"Financial markets are once again pricing upwards of two Bank of England rate hikes this year. Governor Andrew Bailey won't like that," says James Smith, Developed Markets Economist at ING Bank.
UK bond yields rose in response to last week's set of UK data releases which roundly beat expectations. Rising bond yields mean domestic monetary conditions in the UK have already tightened (for example, mortgage rates have risen), without the Bank of England having had to do anything.
Add to this oil and gas prices settling, albeit at high levels, and some on the Monetary Policy Committee might be inclined to push back more actively against rate hike expectations.
"After last month’s surprising show of unity, we expect the old divisions among committee members to come back to the fore. Though the framing has naturally shifted from 'cut or hold' to 'hold or hike', we’d expect the prior doves to place more emphasis on the differences with 2022 at this meeting than they did at the last," says Smith.
Don't let the rate decide.
You decide.
Similar to the Federal Reserve, these MPC members will argue that economic conditions in 2022, when Russia's invasion of Ukraine sparked an energy crisis, are vastly different to underlying conditions today.
Back then, interest rates were low and households were flush with cash saved during the pandemic.
Thus, the odds of a second-round inflation spiral are contained, negating an imminent need to hike rates.
If that's the takeaway of the day, pound sterling can settle lower against the dollar. However, we think weakness will be shallow and remind readers it's ultimately the dollar that decides where GBP/USD goes.
And on that count, we're still in a phase of broad USD trend weakness.
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