The GBP/USD pair had a confident week, with the British pound intensifying the bullish stance on Wednesday on upbeat GDP and jobs data coming from the UK. At the end of the week, the sterling is supported by expectations that the Bank of England (BoE) would increase the interest rates by the end of this year.
Elsewhere, the greenback has lost some ground against majors, with the USD Index, which tracks the dollar against six other currencies, breaking below the support level of an uptrend that took off early September. The index rose to the highest in a year but found strong resistance at 94.500 and has been pulling back.
GBP/USD rose about 1% for the week, which is the highest weekly gain since mid-August. The pair has been bullish since the end of September, bottoming out on September 29 at 1.3411, which was the lowest since December. Since then, the sterling has had a great two-week period, currently trading at 1.3746, which turns out to be a key resistance level. If the pair manages to break above it, it’s free to go as high as 1.3850 in the coming days.
UK Releases a Series of Upbeat Economic Data
On Wednesday, the UK’s Office for National Statistics (ONS) reported that Britain’s economy came back to growth in August after contracting in July for the first time in six months. The GDP performance added to investors’ confidence that the BoE would consider a rate hike before the end of 2021.
As a rule, when the central bank decides to increase the interest rate, the national currency strengthens versus peers as holding it becomes more profitable.
GDP rose 0.4% in August, slightly lower than the average estimates of economists, after being revised down to show a decline of 0.1% in July.
Darren Morgan of the ONS said:
“The economy picked up in August as bars, restaurants and festivals benefited from the first full month without COVID-19 restrictions in England.”
In annual terms, the economy grew 6.9%, which is 0.2% higher than estimates. Now that the UK economy is back on track, the BoE might rush to tighten the monetary policy amid worries of high inflation, which has been driven by the impact of supply chain difficulties.
The BoE might become the first major central bank to raise rates since the start of the COVID-19 pandemic. Investors expect a rise to 0.25% by the end of December, up from an all-time low of 0.1%.
The ONS data shows that Britain’s GBP is now within 0.8% of its pre-pandemic size, although it’s about 5% smaller than if economic growth had carried on within its 2010-2019 trend.
Elsewhere, the US has almost closed this gap as of today.
Earlier this week, the International Monetary Fund (IMF) forecast that the UK was about to demonstrate the fastest economic expansion among the G7 group, accelerating by 6.8% in 2021. However, even that might not be enough to offset the historical slump that came immediately after the start of the pandemic.
In a separate report, the ONS’ trade data showed that the impact of Brexit on trade relationships between the UK and the European Union was fading away.
On the day before the GDP report, the pound was supported by upbeat jobs data. The ONS said on Tuesday that UK companies expanded their payrolls to a record high in September, up by 207,000 from August. This bodes well for the economic growth, especially as the government’s wage subsidies scheme ended on September 30.
Meanwhile, the unemployment rate fell to 4.5% in the three months to August compared to 4.6% recorded in the three months to July, in line with expectations.
Average weekly earnings for the same rose 7.2% compared to June-August of 2020, slowing from the previous reading of 8.3%.
All in all, given the high inflation that is heading towards 4%, which is way above the central bank’s 2% target, the BoE is indeed preparing for an interest rate hike.
Fed Ready to Reduce Bond Buying Next Month
The US dollar rose to the highest in a year against majors, but it has been corrected since Wednesday following the release of the consumer prices index (CPI) update, which shows that high inflation might be persistent rather than transitory, as the Fed repeatedly claimed.
The US Labor Department reported on Wednesday that the CPI rose 0.4% last month and was up 5.4% year-on-year, which is the largest annual gain since 2008. The Core CPI, which excludes the volatile prices of food and energy components, rose 0.2% from August. Analysts expected a monthly gain of 0.3% in September for the CPI and 0.2% in the Core CPI. The raise in inflation in annual terms was predicted at 5.4%, as we previously reported in our ‘Week Ahead’ post.
Inflation maintains high amid shipping challenges, increasing energy prices, materials shortages, and increasing wages.
Investors are worried that inflation will continue to increase in the coming months, given the surge in the price of energy products, which would force the Fed to increase the interest rate earlier than expected. The central bank still blames supply chain bottlenecks and is waiting for the inflation figure to pull back.
High inflation encourages a more hawkish Fed, which apparently should support the US dollar. However, increasing prices devalue the purchasing power of the national currency, which is why the greenback has lost ground since Wednesday, even as the Fed might reverse the accommodative monetary policy.
Sung Won Sohn, professor of finance and economics at Loyola Marymount University in Los Angeles, told Reuters:
“Inflation is no longer ‘transitory’. Supply-chain bottlenecks are getting worse. The logjam is unlikely to ease anytime soon despite the latest intervention by the White House.”
Meanwhile, the Federal Open Market Committee’s (FOMC) minutes of the central bank’s latest meeting showed that the Fed could start tapering its bond-buying program next month or in mid-December. As of today, the central bank buys $120 billion worth of bonds. The minutes showed:
“Participants noted that if a decision to begin tapering purchases occurred at the next meeting, the process of tapering could commence with the monthly purchase calendars beginning in either mid-November or mid-December.”
The Fed aims to end the taper of its bond-buying program in mid-2022, suggesting a taper of about $15 billion per month. The minutes said:
“The path featured monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities.”
What’s Next for GBP/USD?
Given that the Fed is not decided yet when to start increasing the interest rates from their record lows, the BoE might become the first major central bank that increases the rate. This sets the stage for a bullish pound versus the US dollar.
Even if the Fed starts reversing its easy monetary policy by reducing the bond-buying program, the decision has already been priced in, which leaves the American currency without any major fundamentals backing its bullish ambitions.
This means that the GBP/USD pair might attempt to continue the bullish move until getting closer to 1.3900 in the coming weeks and update the highest since August. If bulls fail to move the pound significantly higher, the pair will find strong support near 1.3570.
Much depends on UK inflation data scheduled for next week, with the ONS preparing to publish the consumer prices index and retail sales data.