The GBP/USD exchange rate has moved higher over recent days on a combination of a more optimistic-than-expected assessment of the UK economic outlook at the Bank of England and signs that the US Federal Reserve might only raise interest rates on three occassions in 2017.
This combination of central bank developments led to a jump in GBP/USD in the second half of last week from 1.2100 to 1.2400.
More upside may be difficult to achieve, however, as the exchange rate has now reached the 50-day moving average at 1.2390 and it is likely to impede future progress.
We see the possibility here of the exchange rate stalling and churning at the 1.2400 level as the bulls and bears battle it out, or even pulling back.
That the Pound may retrace some of its gains and the Dollar rise is the view of some analysts so there is a risk the pair could suddenly begin retracing the whole rally from 1.21.
The Bank of England's more positive analysis does not square with recent data, for example, which indicates a deterioration - not improvement in most economic data results.
The Fed were also viewed as unnecessarily cautious by some who think the pace of interest rates rises may actually be steeper than supposed.
Whilst it’s too early to call a reversal in the short-term trend from up to down, we will be monitoring the situation closely for signs of the a breakdown.
For a continuation of the uptrend established last week, we would want to see a clear break above the 50-day MA and the downtrend line at 1.2450.
Such a move would be confirmed by a break above the 1.25 level and would generate an upside target at 1.2600 where a major trendline and the R1 monthly pivot are situated.
Data, Events to Watch for the Dollar this Week
Durable Goods Orders on Friday, March 24 are the focus of the week for the Dollar, although they are unlikely to cause much volatility according to Raiffeisen Research, who see a rise in orders for aircraft from Boeing offset by a fall in general capital goods buying.
Raiffeisen’s Veronika Lammer sees Orders rising by 0.5% in February from 2.0% previously versus 1.1% expected.
Housing data, out at 14.00 GMT on Wednesday, March 22, constitutes the other main release this week, with Lammer expecting a slowdown.
“The available indications suggest a noticeable fall of around 5.0% since January (in Existing Home Sales).”
She further adds:
“New Home Sales should also have shown a declining development, we assume a month-on-month minus of 1.0 to 2.0%.”
On the Dollar’s unexpected reaction to the Fed’s March meeting rate hike, Lammer is sceptical, saying the market got it wrong and the Fed is likely to raise interest rates more not less aggressively in the medium term, thus suggesting Dollar shorts may unwind.
Sterling's Rally Built on Sand?
The Pound rallied following the Bank of England’s (BOE) last meeting because the market had not expected such widespread optimism amongst officials.
Kirsten Forbes, for example, voted for a rate hike and other officials voiced similar thought’s judging from the minutes.
“Other members noted that it would take relatively little further upside news on the prospects for activity or inflation for them to consider that a more immediate reduction in policy support might be warranted,” said the meeting minutes.
But the BOE’s optimism does not reflect recent data, which has actually shown a slight deterioration over the preceding quarter warns to advisory service Capital Economics.
They note how the Purchasing Manager survey data, for example, is showing a GDP growth of only around 0.4% in Q1 against BOE forecasts of 0.6%.
Retail sales have also slowed.
“Early hard evidence such as the surprise dip in retail sales volumes in January, adds to the view that the near-term risks to the MPC’s activity forecasts may be skewed to the downside,” says economist Paul Hollingsworth at Capital Economics.
The imminent triggering of article 50 will officially kick-start the UK's exit of the European Union and usher in a period of uncertainty which is likely to impact on economic growth.
Sterling’s current rally may therefore be built on sand.
The Week Ahead for the Pound: Inflation Data will be Key
As far as upcoming data releases go, the main release for the Pound is the February CPI due for release on Tuesday, March 21 at 9.30 GMT.
Market expectations for a rise to 1.8% are a little low according to both Capital Economics and TD Securities, who estimate a higher 2.1% and 2.2% rise year-on-year in Feb.
The main contributory factors are likely to be rising food inflation due to the weak Pound and the lagged effect of the rebound in oil prices.
Producer Prices in the UK, out at the same time are expected to show continued extremely high yearly gains in ‘Input prices’ due to the rise in imported component prices because of the weak Pound.
Capital expect Input prices to rise by 21.7% year-on-year.
Manufacturers are not passing the higher costs on, however, as output prices are only rising at a fraction of the level, of 3.5% currently, rising to 3.8% according to Capital.
“Meanwhile, the survey evidence suggests firms have been taking a hit to their margins. Indeed, the output prices balance of the Markit/CIPS survey has not risen by nearly as much as the input price balance. As such, we expect output prices to have increased only a little further, from 3.5% to 3.8%.,” said Holingsworth.
On Tuesday, March 21 at 9.30 Public Borrowing data is released and should show a small 1.0bn rise in February.
Nevertheless, borrowing remains below previous forecasts – down 22% on the previous year allowing the public finances some breathing room.
Given the government’s U-turn on increasing National Insurance contributions from the self-employed and lower-than-expected borrowing, the government does now have a buffer it can use to stimulate the economy in case of a Brexit-related slowdown, factors Sterling’s current rebound may be based on.
The final big news release for the Pound is Retail Sales at 9.30 on Thursday, March 23.
“February’s retail sales figures are likely to suggest that consumer spending is on track for a disappointing first quarter,” said Capital’s Hollingsworth.
He further notes this appears to be as a result of a correlated fall in real earnings growth.
The consensus market estimate is for sales to have risen by 0.4% month-on-month and 2.6% year-on-year, whilst Capital are slightly more optimistic seeing 0.5% and 2.7% rises respectively.
Notwithstanding this slightly brighter forecast the remain pessimistic about the outlook for Retail Sales in Q1.