The Pound Retakes and Holds Key Level of 1.600 GBP to USD

There is a raging battle between the US dollar and British pound (GBP) for the region around the key psychological level of 1.600 - we have seen the level broken and regained on numerous occasions this week.

We said the 1.6000 level would be important for the GBP/USD's outlook earlier this week, and this view remains relevant. One gets the sense that sterling will have seen the worst of recent declines if the level remains unbeaten as we move through October.

At the weekend the pound dollar exchange rate (GBP-USD) is shown to have held onto 1.6088 ensuring the Thursday rally is defended.

PS: The above quotes are taken from the wholesale markets, your bank will affix a spread to the rate at their own discretion. By actively seeking out a better rate with an independent FX provider you could get closer to the market and save up to 5% more FX in the process. Please find out how.

US Dollar Slumps - and Then Recovers

The catalyst behind GBP's ability to keep the USD at bay will have been the softness of September US retail sales and NY Empire Manufacturing data.

Traders were rudely made aware of the fact that the US economic recovery is not invincible and could start to slowdown; this has pushed back the first US Federal Reserve interest rate hike.

"EUR/USD spiked to 1.2886, GBP/USD hit 1.6068 as US yields dropped sharply," notes Ipek Ozkardeskaya at Swissquote Research in reference to the sudden fall in the dollar in the mid-week trading session.

The GBP/USD rally remained short-lived however; "sentiment in euro and pound remains negative given the soft recovery concerns. The strong labour data out of the UK failed to revive GBP-bulls yesterday. Given the soft inflation dynamics, markets now price in a delay in BoE’s first rate hike," says Ozkardeskaya.

Indeed - the one major risk to the pound's outlook is the dovish shift in expectations regarding the Bank of England's interest rate hiking programme.

This should further weigh on GBP-complex moving forward and will ensure any gains in the pound dollar rate will likely be capped.

Furthermore, the initial sell-off in the dollar appears to be misplaced, "the USD came under pressure after some weaker than expected US data yesterday. However, the numbers were nowhere near weak enough to justify the sharp decline in US yields, and subsequently the moves were quickly pared back," say Lloyds Bank.

Are Markets Overly Cautious on GBP?

We join those in the foreign exchange world who believe sterling has been punished too severely.

Indeed, looking at the latest moves in the pound euro exchange rate once can see how this happens. GBP/EUR has been pummelled in recent days despite the clearly dominant position the UK economy finds itself in when compared to the Eurozone.

It took one big sell order to show the euro was overvalued and the euro came crashing down.

Perhaps in time the FX market will take the same view on other major GBP pairs?

Indeed, Lloyds Bank Research believe that the culprit for a weaker sterling in recent times has been the decline in UK sovereign bond yields, and this could present an opportunity:

"The move lower in US yields in the afternoon dragged UK yields lower with it. This subsequently left market pricing for the first rate hike for end-2015.

"We view market rate expectations are too dovish at present. We still think it is likely that UK interest rates will rise well ahead of prevailing market expectations, and that spread widening associated with this will support GBP."

Poor UK Inflation Could Keep Investors Coy on Sterling

Western Union remind us that one of the reasons for GBP's weakness this week may keep the currency under pressure moving forward:

"Sterling kept close to 11-month lows, still reeling in the wake of the weakest U.K. inflation in five years. The benign outlook for prices seemingly bought Britain’s central bank additional time to keep rates low.

"The low inflation climate trumped data this week that showed British unemployment neared a six-year low of 6.0 percent.

"The pound may be upside challenged for the foreseeable future on uncertainty ahead of U.K. elections in May and worries that U.K. exports could suffer if its key trade partner in the euro zone should tip back into recession."