GBP/USD Week Ahead Forecast: Overbought

U.S. retail sales are in focus this week. Image © Adobe Images

Pound Sterling has risen to its highest level in a year against the Dollar after last week's 1.35% gain. But, the rally leaves it technically overbought in the near term and exposed to weakness if this week's inflation and wage figures undershoot expectations.

The Pound to Dollar exchange rate hit a high of 1.2990 on Friday and holds onto these gains as Monday brings about a busy week for the British currency.

The pair quotes at 1.2976 at the time of writing, which means the most competitive payment rates on offer are now near 1.2914. The odds of a pullback are high, with the daily RSI now reading at 72.98.

Above: GBP/USD at daily intervals with the RSI in the lower panel. Track GBP/USD with your custom alerts; find out more here.

A reading above 70 is consistent with overbought signals. The RSI rarely stays above 70 or below 30 as it tends to revert towards 50. To achieve this, a period of consolidation or weakness must ensue.

Any weakness in the coming days could be restricted to the previous 2024 cycle highs at 1.2893 and 1.2860, respectively.

Weakness is seen as temporary at this juncture as Pound-Dollar trades well above its key moving averages, which confirms the exchange rate is in an uptrend that can continue to extend once a period of consolidation has taken place.

"The cable has surged above its bearish trend line that has persisted since June 2021, hinting at a possible significant upward movement," says Fawad Razaqzada, an analyst at City Index.

Pound Sterling outperformance means it stands at the top of the G10 currency basket for 2024 thanks to a trifecta of developments: 1) improving domestic data, 2) a retreat in Bank of England rate cut expectations and, 3) improved political sentiment.

"The GBP currently has the strongest upward momentum amongst G10 currencies. The UK election result has created a more favourable backdrop for the GBP. The large majority for Labour should ensure a period of much-needed political stability in the UK," says Lee Hardman, an analyst at MUFG Bank Ltd.

The key tests for the Pound come from this week's inflation and wage figures. Services inflation is expected to read at 5.6% and headline CPI inflation is forecast to read at 2.0%. Any undershoot would raise the odds of an August 01 rate cut and send an overbought Pound-Dollar sharply lower.

Analysts at Oxford Economics reckon the headline CPI inflation print will be 1.8%, which would represent a decent undershoot and prompt a selloff in the Pound.

"Considering the GBP has been the best performing G-10 currency QTD, we think it remains prone to a larger correction if CPI print comes in lower than expectations," says Daragh Maher, Head of FX Strategy at HSBC.

However, the sell-off in the Pound would be limited because the Bank of England will find it difficult to cut aggressively if the economy continues to perform robustly, something several economists said was likely following last week's GDP release.

Regarding the wage numbers on Thursday, the expectation is for average weekly earnings to have increased by 5.8% over the year to June. Anything below here would result in GBP selling.

Pound-Dollar's performance nevertheless reflects Dollar weakness more than anything. We note that the dollar has come under pressure over recent days as investors settle on a high likelihood that the Federal Reserve will cut interest rates for the first time in September.

Confidence was boosted by last week's undershoot in U.S. CPI inflation data. Pound-Dollar smashed through the 1.29 barrier to quote at a new 2024 high of 1.2935 after U.S. CPI inflation printed -0.1% month-on-month in June, down from 0% in May and below expectations for a 0.1% rise.

"Turbo-charging the pound’s recent uplift was data showing US inflation cooled last month, boosting bets of more Fed rate cuts this year and next," says George Vessey, Lead FX Strategist at Convera.

Money market pricing shows the odds of a September interest rate cut at the Fed are now priced as a near certainty after the headline inflation rate fell to 3.0% year-on-year from 3.3%, undershooting expectations for 3.1%.

Tuesday's retail sales will be the U.S. data highlight of the coming days, shedding light on demand in the economy. The market's expectation of an undershoot of the 0% m/m figure could result in further USD weakness as the Fed would become increasingly confident that the disinflation process was underway again.