Pound / Dollar Forecast at 1.59 at Start of 2017: Bank of America

Expectations concerning impending interest rate rises at the US Federal Reserve are forecast to keep the US dollar supported, but the British pound could be the one currency that resists USD strength.

Bank of America Merrill Lynch are expecting the current period of appreciation in the US dollar complex to continue over coming weeks.

Expected strength across the USD complex, when combined with expected volatility owing to the UK’s EU referendum, should keep any strength in the GBP to USD conversion capped.

At the time of writing the GBP/USD exchange rate is seen at 1.4704, in fact the British pound was the only currency to register a gain against the US dollar in the week ending 19th May.

This suggests that while the dollar has enjoyed strength this month, so too has the GBP which continues to recover its Brexit-inspired losses.

Latest Pound / US Dollar Exchange Rates

	Live: 1.3349▲ + 0.17% 12 Month Best: 1.3789
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A US Fed Rate Rises Could Come in June

US dollar strength has largely been founded on the rise in expectations for a more ‘hawkish’ US Federal Reserve, i.e one that is confident enough to raise interest rates and tighten monetary policy.

This improves the attractiveness of the United States as a potential destination for investor funds in a world that is starved of yield.

The April minutes of the Federal Open Market Committee (FOMC) revealed a greater willingness to consider a June rate hike than market pricing or recent consensus among economists would suggest.

Indeed, "some" voting members thought that market pricing of a June rate hike "might be unduly low." While "most" participants thought that a case for hiking in June could be made if their forecasts for improving 2Q growth, continued labor market strength, and progress on inflation were met, "several" worried that "incoming information might not provide sufficiently clear signals" in time.

The FOMC otherwise was divided on several issues, and the voters generally agreed that it would be "appropriate to leave their policy options open" and "maintain flexibility."

Bank of America say rate hikes this summer remain a possibility, conditional on the outlook. However, their base case remains a patient Fed that next hikes in September.

Analyst Ian Gordon says a realisation that rates are to rise is likely to play pro-USD over the near-term:

“The Fed minutes echoed the tone of recent Fed speakers who have pushed back against dovish market pricing, arguing June or July hikes remain likely given recent positive economic and global market developments.

“Alongside a better tone to US data in recent days and more neutral dollar positioning, a continued increase in the number of market-implied hikes has room to further support the USD.”

However, given the Fed's still data-dependent stance and how far market-implied expectations have come, Gordon reckons the USD impact could diminish unless US data momentum picks up meaningfully, particularly if increased Fed expectations raise market concerns about China.

“Therefore, while we see further USD upside potential if chances of a summer hike increase, we would caution against broad-based USD longs until stronger US data eases market concerns about potential negative spillovers of further policy normalisation,” says Gordon.

With this profile for the US dollar in mind, Bank of America are forecasting the GBP/USD exchange rate to rise to 1.53 by the end of September 2016, ahead of a rise to 1.59 at the turn of the year.

It would appear to us that the forecasts are calibrated a little to the generous end as the forecasts for June 2016 are at 1.54.

We would hesitate to dismiss them though as there could certainly be a notable relief rally were the UK to vote to Remain in Europe.

That said, research in from Societe Generale suggests that any such rally would leave the pound sterling looking notably overvalued against the US dollar based on 2 year interest rate differentials between the US and UK.

But Bullish on the US Dollar, EUR/USD Forecast Below 1.10

While the pound / dollar exchange rate is forecast to rise from current levels, Bank of America are dollar bulls.

This would suggest gains are likely to be realised elsewhere.

“Our baseline bullish USD view now assumes the Fed hikes 1 time in 2016 and 2 times in 2017,” says Gordon, “the market is currently not pricing the next full Fed hike until September 2017, a much more dovish outcome than our Economists expect.”

Given market pricing and the downgrade of BofA’s Fed forecasts, risks are more balanced in their USD forecasts now as it is unlikely for the market to lower the implied policy path much further.

Assuming the Fed hikes forecast by the team at Bank of America, Gordon continue to believe the USD has more room to positively respond with the Fed signal in his decomposition model only accounting for around 35% of cumulative USD moves since 2014.

“Additionally, the prospect for further overseas and the implied balance sheet divergence will provide residual USD support even if the Fed normalises slowly,” says Gordon.

As a result, the euro / dollar exchange rate is forecast to fall to 1.10 by September and 1.08 by the turn of the year.