GBP/USD Rate Routed, Fresh 1985 Lows in Play

• GBP/USD falls to 1985 lows
• Amidst ongoing USD strength
• But clear distate for GBP in markets evident
• As UK retail sales slump
• And amidst expectations for BoE disappointment
• Next week's 'mini budget' also a risk

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The British Pound is being routed by the Dollar in the wake of further disappointing UK economic news and expectations the Bank of England will disappoint next Thursday.

The Pound to Dollar exchange rate (GBP/USD) fell to its lowest level since 1985 on Friday at 1.1350 after it was reported UK retail sales contracted 1.6% on the month to August, leaving economists to suggest the UK economy is already in recession.

GBP/USD spot is at 1.1342 at time of update, taking bank account transfer rates to around 1.1150 and those at payment providers to around 1.1342.

"The 1.6% m/m drop in retail sales volumes in August supports our view that the economy is already in recession," says Olivia Cross, Assistant Economist at Capital Economics.

The ONS said declines were registered in all sectors, including online.

Declines by Sterling come ahead of next week's Bank of England policy meeting where currency traders appear to expect another disappointment in the form of a smaller-than-expected interest rate hike.

Friday meanwhile sees the government deliver a 'mini budget' as the new government of Liz Truss attempts to press the reset button on the economy.

She will deliver estimates for the cost of her energy price cap plan and a strong of other measures expected to boost the UK's debt burden.

"Among the notable moves in markets: Sterling is down another 0.9%, trading with a 1.13 handle.
This is more than dollar strength. Coming on the heels of the weak retail sales data, it reflects markets’ attempts to price in next week's details on the UK government’s fiscal package," says Mohamed A. El-Erian, President at Queens' College, Cambridge University and advisor to Allianz.

The headwinds facing the British Pound are "very strong" according to new analysis from Rabobank, which forecasts the printing of fresh 2022 lows against the U.S. Dollar within weeks.

GBP/USD remains caught in the grip of a downtrend that took it to 1.1400 briefly on Sept. 07, its lowest level since March 2020 when the market was in the grip of the coronavirus panic.

The Dollar's dominance over all others is one important reason for the decline in GBP/USD and Rabobank tells clients the world's de facto currency is not ready to retreat.

"The USD is likely to remain well supported for several months with the hawkish position of the Fed underpinning the attraction of the greenback as a safe haven," says Jane Foley, Senior FX Strategist at Rabobank in London.

Above: GBP/USD at four-hour intervals. To keep on top of the market and set a free FX rate alert here.

The Dollar surged again this week following the release of U.S. inflation data that came in ahead of consensus expectations, leading investors to bet the Federal Reserve will continue to aggressively tighten monetary policy in an attempt to slow the economy and inflation rates.

This is supportive of U.S. yields - an attraction to international investors - but negative for stock markets, which in turn creates an additional bid for dollars as positions are closed out and demand for cash rises.

The Pound is particularly vulnerable to Dollar strength relative to its peers, owing to weak domestic fundamentals according to financial market forecasters.

Rabobank says a wall of worries include the negative outlook for UK growth, compounded by the recent lack of political leadership, higher national debt and a widening in the UK’s current account deficit.

"It is clearly more difficult to assess when speculators will judge that there is sufficient bad news in the price," says Foley.

She says the new Prime Minister Liz Truss must meanwhile try and win back investors by smoothing relations with the EU.

Concerning the Bank of England, Foley has no conviction on the size of the expected rate hike at next Thursday's Monetary Policy Committee meeting.

In fact she says what the Bank does is of less concern to the market than the UK economy's growth outlook which will now be heavily influenced by the government's energy bill cap, announced last week.

We nevertheless note numerous investment bank analysts are of the view the Sept. 22 Bank of England decision will be very important for the Pound. They argue the Bank has been consistently behind the curve when tackling inflation and delivering the rate hikes the market is looking for.

The Bank of England is also failing to convince the general public it has a grasp on inflation: it's own quarterly Inflation Attitudes Survey, released on Sept. 15 revealed the greatest level of dissatisfaction with the Bank's inflation fighting efforts since its inception in 1999.

One-third of people in the UK were dissatisfied with how the central bank was controlling inflation, according to the survey, net satisfaction fell to -7%, also a record and the only other negative reading since May’s minus 3.

The Bank will also be concerned about the level of entrenched inflation expectations amongst the public: the median expectation for the rate of inflation over the coming year was 4.9%, over a two year period it was 3.2% and over five years it was 3.1%, which is well above the Bank's 2.0% target.

Credit Suisse says the Bank must go as hard as 100 basis points and aim for a terminal Bank Rate of 5% if the UK is to attract the foreign investor capital required to fund the current account deficit.

Regarding the economy, it will be some time before the impact of the decisions taken by the new government start showing up in the data, leaving Sterling exposed to the current investor gloom.

"We expect further weakness for the pound in the coming weeks," says Foley. "For now, the headwinds facing the pound are still very strong. We maintain our 1 month forecast of GBP/USD 1.14."