GBP Strengthens in October, Can It Go Higher?

The pound has had a strong month against the US dollar and the euro, although GBP/USD has corrected during the last trading day of October and broke below the support level of the month-long uptrend.

The main driving force behind the sterling’s bullish stance relates to investors’ expectations that the Bank of England (BoE) will become the first major central bank to start raising the interest rate.

GBP/USD has increased by 1% so far this month, while EUR/GBP has dropped by about 1.25%, reflecting a strengthening pound that has managed to recover September losses, when it tumbled to the lowest level year-to-date versus the US dollar.

Still, despite a strong October, GBP/USD showed signs of weakness on Friday after finding strong resistance near 1.3800. In fact, the daily chart shows that the pair has been moving inside a bearish long-term channel that formed in May. If it follows the channel’s logic, then we may see the pair updating the YTD low as soon as November.

However, bulls shouldn’t be discouraged because when we check even larger timeframes, we get a different picture. Specifically, the 1W chart suggests that the price action has formed a flag pattern. Since this is treated as a trend continuation pattern, we may see the pair breaking above the flag’s resistance soon to continue the long-term uptrend that took off early in 2020 near 1.1500 to push the price above 1.400 as of May 2021.

Fundamentals Driving the Pound

During the last two weeks of October, the sterling has been gaining momentum on a series of economic data suggesting that the central bank is free to increase the interest rate as early as this year. Here are the main economic reports and events that shaped the forex pairs involving the pound:

UK Annual Pay Shows Biggest Increase since 2008

On Tuesday, October 26, government data showed that full-time earnings had increased by the most since 2008 in April, up 4.3% from the previous year. Economists agreed that the government’s furlough scheme had likely contributed to the growth. The report, prepared by the UK’s Office for National Statistics (ONS) reflects the British labor market health, taking into account way more workers than its monthly figures. Speaking about the monthly report, which was released on October 12, it suggested that average earnings plus bonuses exceeded expectations in August, coming in at 7.2%.

The ONS said in its latest report:

Pay increased for most workers in 2021, but particularly those that were most affected by the pandemic in 2020, most notably younger employees, men and the lowest-paid occupations.”

Tuesday data added to expectations that the Bank of England would raise the interest rate, pushing the pound higher versus the dollar and the euro, especially when the European Central Bank (ECB) will likely be the last one to consider a rate hike.

Still, expectations of higher rates from the BoE could have provided an even more solid boost to the pound, but the uptrend has been capped by not-so-convincing growth data. Lee Hardman, FX strategist at MUFG Securities, told Reuters:

There is an element of caution in chasing the pound higher on the back of higher rates. The combination of slower growth and higher inflation is not a good mix for a currency.”

British Retail Sales Unexpectedly Decline in September

On Friday, October 22, the ONS released disappointing retail sales data, which reflected a significant slowdown in economic growth, which doesn’t allow the sterling to extend its bullish ambitions. Retail sales surprisingly declined in September for the fifth straight month despite higher fuel sales.

Sales volumes declined 0.2% for the month, mainly because of supply-chain issues, which led to the longest run of consecutive monthly drops on record. Analysts anticipated an increase of 0.5%.

After a major rebound early in the year, retail sales stalled in April. The indicator fell 3.9% in the three months to September, slashing 0.2% from the GDP growth.

Separately, a few days later, the Confederation of British Industry (CBI) said that UK retailers had reported better-than-expected sales in October after a plunge in September, although supply chain problems cut their stocks to the lowest on record.

UK Composite PMI Surprisingly Edge Up in October

The same day when the ONS revealed the disappointing retail sales results for September, private market research firm IHS Markit released the whole package of preliminary purchasing managers index (PMI) data for October, which suggested some acceleration of the British economy and thus supported the case of a rate hike.

The flash IHS Markit/CIPS Composite PMI increased by the most since May to touch 56.8, up from 54.9 in September, while analysts expected a further slowdown to 54.0.

https://www.markiteconomics.com/Public/Home/PressRelease/6c4111f9b7054ecba6a8e85eedb9ebf7

Nevertheless, IHS Markit’s chief business economist, Chris Williamson, said the rebound might not be sustainable. He explained:

The service sector is clearly in something of a sweet spot. Rising COVID-19 case numbers pose a downside risk to growth in the coming months, potentially deterring some services-oriented activity … and potentially leading to the renewed enforcement of health restrictions as winter draws in.”

Last week, the UK reported more than 52,000 new COVID cases in a single day, the highest since July and more than anywhere else in Europe.

UK Inflation Slows in October, But That’s Temporary

Earlier this month, the ONS said that UK inflation surprisingly slowed in September, but the drop was likely temporary and wouldn’t influence BoE’s decision to increase the rates.

Consumer prices gained 3.1% year-on-year in September, contracting from a 3.2% increase in August, although economists expected a similar figure for last month.

Yael  Selfin, KPMG UK’s chief economist, told Reuters:

We expect further increases in inflation from October, which could reach around 4% by the end of the year, with the recent rise in wholesale energy prices passed on to households.”

https://www.reuters.com/world/uk/uk-inflation-declines-unexpectedly-september-ons-2021-10-20/

In September, the BoE said it had anticipated inflation to break above 4% in Q4 of 2021, but since then, energy prices have surged even more.

Last Tuesday, bank Citi said that the British public’s expectations for inflation over 2022 jumped to the highest since the financial crisis in 2008.

What’s Next for the Pound?

On Thursday, November 4, the Bank of England will meet to decide the interest rate, which will be crucial for shaping the next major trend. Investors expect that the central bank may raise the interest rate from the current’s record low at 0.1% to 0.25%. However, most economists surveyed by Reuters anticipate that the BoE will wait until early 2022.

Earlier this week, UK’s finance minister Rishi Sunak presented the annual budget, predicting stronger GDP growth and lower borrowing. However, the expected 5% inflation next year is slashing the greatest chunk of the projected growth.

While the pound has done great in October, many believe it cannot maintain these gains without clear hawkish rhetoric from the BoE next week. BofA economist Robert Wood said:

There are obvious headwinds to GBP given the amount of tightening that has been priced into the UK rates curve, but this will not be the moment for a dovish hike.”

GBP/USD and EUR/GBP will show more volatility at the end of next week as the BoE reveals the interest rate decision, but ultimately the focus will switch to the longer-term economic growth potentially being hit by supply chain disruptions, Brexit, and monetary tightening.

In the short-term, 1.3800 remains a strong resistance for GBP/USD, but that level can be challenged if the central bank sends a hawkish message on Thursday.

 

 

 

 

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