British Pound Tipped for Gains Over Dollar, Euro in Weeks Ahead; Economic Data in Focus

• Spot market quotes:
• Pound-to-Euro exchange rate today: 1 GBP = 1.1359 EUR
• Pound-to-Dollar exchange rate today: 1 GBP = 1.3327 USD

November's inflation and wage data are now in focus, but the European Council and "sufficient progress" on Brexit are still key despite a breakthrough in talks.  

The Pound is set for further gains during the weeks ahead, according to strategists, who say the risk premium carried by the British currency should diminish in proportion to progress in the Brexit negotiations.

You wouldn’t necessarily be able to infer that from Tuesday’s price action though. The start of the new week had seen sentiment toward Sterling improve after the Conservative government's backbench MPs rallied around Prime Minister Theresa May for her efforts in Brussels last week.

Since then the British currency appears to have faltered, ceding ground to a stronger Dollar on Tuesday and just about managing to cling onto a 40 point gain over the Euro, - which was thanks in large part to greater weakness in EUR/USD.

Yet, should the Pound not be higher? Many watching the currency markets had expected greater gains after the PM returned from Brussels Friday claiming the Brexit negotiations will move forward following Thursday’s European Council summit.

Recent price action could suggest a lingering sense of unease among traders over whether talks really will be able to move onto the subjects of trade and transition, or apprehension ahead of Wednesday’s wage data and Thursday’s Bank of England meeting.

While the outlook for the Pound is certainly improved, it could be a case of cautious yet steady gains ahead.

Sterling to "Edge Higher" vs. Euro and Dollar say Analysts

Prime Minister Theresa May reached a tentative agreement with the European Commission last week, which provides a basis for a “financial settlement”, protecting European Union citizens rights after Brexit and avoiding physical infrastructure at the Northern Irish border.

Season 1 of the reality TV show that is 'Solving Brexit' did drag on a bit... but still ended on a high #BrexitDeal. Tune into Season 2 in January as plot twists include transition deal & trade (spoiler alert!)
Here's our chain of logic for why we think #GBPUSD can go to 1.40 pic.twitter.com/y9acQ1u8Sg

— Viraj Patel (@VPatelFX) December 8, 2017

Brussels negotiators made demands across the three areas, which had to be satisfied or overcome in order for talks to move along to the subjects of trade and transition.

“GBP/USD has scope to edge higher over the coming week,” says Elias Haddad, a senior currency strategist at Commonwealth Bank of Australia. “Faster UK wage growth on Wednesday can further underpin GBP.”

Friday's agreement now clears the way for talks to progress, which is seen as important if the UK is to avoid a so-called "hard Brexit", where it exits the EU and defaults to trading with it on World Trade Organization terms.

“The Bank of England meeting is probably now the standout event this week; while we suspect the statement will be largely unchanged, it’ll be interesting to see whether the MPC explicitly acknowledge the recent Brexit progress. If so, one could see this as a hawkish development – with risks GBP/USD moves up to 1.3500/50,” says Viraj Patel, a strategist at ING Group.

With fear around Brexit easing, the market's attention is now seen turning back to economic data and and the Bank of England meeting Thursday, all of which will be key for expectations around the path of interest rates in the UK.

"As on several other occasions in the past 12 months or so Sterling prices here are currently struggling to establish themselves above an important resistance point -in this instance at 1.1500," says Lucy Lillicrap with AFEX, a foreign exchange brokerage based in London.

Provided the market can hurdle this psychological level over the next few days, Lillicrap says an intermediate base can still be confirmed with enough compression to enable a subsequent extension toward 1.1650/1.1800 as well. So these are some numbers for those wanting a stronger Pound to keep an eye on.

"GBP/USD liquidity appears solid and upside is likely to have limits given the size of the unknowns ahead for the Brexit deal," says Neil Jones, head of corporates & financial institutions group for MENA & Central Asia at Mizuho Bank.

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Inflation and Wage Data Matter Most for Sterling this Week

The Pound recovered ground against the Euro and Dollar Tuesday after the UK consumer price index posted a surprise increase for the month of November, taking it above the crucial 3% threshold for the first time since April 2012.

November’s CPI measure means the Bank of England governor will now need to write a public letter to the chancellor setting out how the Monetary Policy Committee intends to return inflation to its 2% target.

The consumer price index rose to 3.1% in November, from 3% in October, against market expectations for a steady reading of 3%.

Rising prices for air fares as well as recreational goods, notably computer games, were behind the upward move according to the Office for National Statistics report.

Core inflation, which removes volatile food and energy goods from the basket, held steady at 2.7% for the month.

Tuesday's data is important for Sterling given that future Bank of England interest rate rises will be contingent upon inflation remaining above the 2.0% target throughout the multi-year forecast period.

"All in all, there is little here to suggest that the MPC needs to raise interest rates again quickly to stamp out inflationary pressures. Indeed, we think that CPI inflation has probably now peaked," says Paul Hollingsworth, an economist at Capital Economics.

However, the rub for Sterling bulls is that increasing numbers of economists now expect inflation to begin falling back from the 3.1% peak seen in November, as the effect of the historic 2016 fall of the currency drops out of the prior year comparison.

Market expectations for the path of UK interest rates, and therefore the fate of Sterling, will be dictated largely by how far and how fast inflation falls.

Wednesday’s wage data, which comes ahead of Thursday’s Bank of England meeting, will also be important for Sterling in the context of Tuesday’s inflation report.

"Tomorrow’s wage growth figures are likely to indicate that underlying cost pressures remain subdued too," adds Capital Economics' Hollingsworth.

Higher inflation, which is itself the result of the post-referendum fall in the Pound, is the principal driver behind the fall in “real incomes” that has pressured the inflation adjusted value of consumer spending and “real GDP” in recent quarters.

It is therefore, the driver behind the economic slowdown that so much has been made of in recent times. 

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