Pound to Test 1.25 Mark Against Dollar if U.S. GDP Disappoints

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The Pound to Dollar exchange rate (GBP/USD) has recovered alongside global equity markets and a push to 1.25 is possible if Thursday's U.S. GDP reading disappoints.

GBP/USD rebounded half a per cent in midweek trade to a high of 1.2490 as "a cautious calm returned to markets," explains Joe Manimbo, Senior Currency Analyst at Convera.

The Pound, Euro and other major currencies were on sale against the Dollar just 24 hours earlier amidst a broad pullback in global equities as investors reacted to fresh concerns about the U.S. banking sector.

The mid-tier lender First Republic Bank said it suffered $100BN in deposit outflows during the first quarter as banking sector fears grew following the collapse of Silicon Valley Bank and Signature Bank, a disclosure that rekindled old fears.

But First Republic Bank still stands and there are no signs of stress elsewhere in the sector, meaning those fears have been pared. "The euro and sterling climbed back into positive territory for the week, with the former back within striking distance of recent one-year peaks," says Manimbo.

The next key development on the horizon for GBP/USD is Thursday's preliminary U.S. GDP estimate, due for release at 13.30 BST.

The figure is expected to undershoot expectations by economists at Wells Fargo, the U.S. commercial, retail and investment bank.

If they are correct, the surprise could result in further Dollar weakness that would allow GBP/USD to recover back towards the 1.25 region.

Wells Fargo says an official revision to U.S. core retail sales this week means headline GDP will significantly undershoot consensus expectations when released on Thursday.

The Commerce Department revised data on core retail sales this week to show substantially slower growth in January and February, implying considerably less growth in personal consumption expenditures (PCE) in the first quarter than first reported.

"As a result, we have reduced our real PCE growth forecast for Q1 to 2.6% from 4.4% previously. This revision to our PCE growth forecast, along with a tweak to our estimate of inventory accumulation, pulls our overall forecast for GDP growth lower by a full percentage point," says Shannon Seery, Economist at Wells Fargo Economics.

Wells Fargo now looks for real GDP to have grown just 0.8% in the first quarter.

As of this writing the consensus expectation is still 2.0%, paving the way for an undershoot.

The Dollar tends to fall on U.S. data disappointments as it raises the prospects of Federal Reserve rate cuts later in the year, meaning if Wells Fargo is correct the GBP/USD recovery could be supported into the weekend.

"While the dollar remains a go-to currency when risk aversion flares, its broader bias has turned negative given the more hawkish outlook for monetary policy abroad," says Manimbo.

But the market could have already sniffed a downside surprise is now possible, suggesting a sizeable downside miss will be required to invigorate GBP/USD gains.

The data release comes just days before the Federal Reserve's May 03 policy decision, which is the next major event on the FX market's radar. A 25 basis point rate hike is expected, but for the Dollar it will be the guidance that matters.

"The Fed would probably have to sound very hawkish to support USD on a sustainable basis though, something that seems unlikely in view of the data situation. The resurgence of market concerns regarding US banks also does not suggest a more hawkish stance. If its communication is merely unchanged, signalling that the Fed considers unchanged interest rates over a prolonged period to be appropriate, the market is unlikely to be convinced to adjust its rate cut expectations. That means it is likely to remain difficult for USD," says You-Na Park-Heger, FX Analyst at Commerzbank.

Those watching GBP/USD should also keep in mind sentiment remains shaky at the current time amidst fears of a looming U.S. recession linked to rapidly rising interest rates.

Disappointing corporate earnings and banking sector concerns can flare up at any time, offering the Dollar bouts of strength, even if it appears to be losing value over a multi-month timeframe.