Pound / Dollar Week Ahead Forecast: Downside Risks Linger as Fed Minutes Eyed 

• GBP/USD struggling to sustain recovery momentum
• Multiple resistances limit upside near 1.33 on charts 
• GBP hampered by uncertain outlook for Bank Rate
• USD underpinned by Fed, relative economic outlook 
• Fed minutes & balance sheet in focus for GBP/USD 

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The Pound to Dollar exchange rate slipped back toward 18-month lows week owing to a strong Dollar and growing uncertainty about the Bank of England (BoE) interest rate outlook, which could continue to limit Sterling’s scope for recovery over the coming days.

Sterling fell widely from early on last week after Bank of England Governor Andrew Bailey suggested financial markets may be overambitious in their assumptions about the interest rate outlook for later this year, and remained suppressed close to 18-month lows against the Dollar on Monday.

Recent commentary and guidance from the BoE has placed a growing question mark over expectations for Bank Rate to reach 2% by year-end and just as Federal Reserve (Fed) policymakers have encouraged financial markets to expect a steep climb in the Fed Funds rate this year and next.

“We think markets are too optimistic on BoE hikes this year so the divergence between the two central banks should become clearer in coming weeks and further pull the GBP towards a re-test of 1.30,” says Juan Manuel Herrrera, a strategist at Scotiabank.

“We spot support in the 1.3100/15 zone followed by 1.3080/90 and firmer at ~1.3050,” Herrera and colleagues said on Friday. 

Above: Pound to Dollar rate shown at 4-hour intervals with Fibonacci retracements of late February decline indicating possible areas of technical resistance to any recovery by Sterling. Click image for closer inspection.

Stubborn increases in U.S. inflation have seen the Fed increasingly guiding investors to expect a full withdrawal of the interest rate cut from 1.75% announced in March 2020 and then some on top over the coming quarters.

This has seen financial market pricing shift to imply a high probability of the Fed lifting the Fed Funds rate as far as 3% by late 2023, which would take the benchmark to its highest since before the 2008 financial crisis and would be in addition to the Fed’s forthcoming effort to shrink its balance sheet. 

“It’ll be faster than the last time and of course it’s much sooner in the cycle than last time. But it will look familiar. I would just say I’m sure there’ll be a more detailed discussion in the minutes of our meeting that will come out in three weeks. I expect we’ll lay out pretty much the parameters of what we’re looking at,” Chairman Jerome Powell said in last month’s press conference. 

The Fed’s plans for its balance sheet are likely to be the highlight of the week ahead for the Pound-Dollar rate and are expected to be released inside Wednesday’s minutes of the March Fed policy meeting.

“We consider the risk lies with a less aggressive run-off of the Fed’s balance sheet compared to expectations. The USD may weaken in response to a less aggressive balance sheet run-off in the minutes,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.

Above: Pound to Dollar rate shown at daily intervals with Fibonacci retracements of late February decline indicating possible areas of technical resistance to any recovery by Sterling, and shown alongside spread or gap between 02-year UK and U.S. government bonds. Click image for closer inspection.

“A negative turn of events in relation to the war is likely needed to push GBP/USD fall through support at 1.3000. GBP/USD is likely to face upside resistance at 1.3197 if the USD falls after the release of the FOMC minutes,” Capurso and colleagues said on Monday, 

The Fed’s balance sheet swelled to $8.9 trillion as a result of its coronavirus-inspired quantitative easing programme, which bought $120BN government and mortgage bonds per month between March 2020 and March 2022.

But now the labour market has recovered from the destruction of 2020 and inflation has sustained its surge above the Fed’s 2% average target, the bank is seeking to return its balance sheet and overall monetary conditions in the economy to a more normal state as quickly as possible 

“Despite much focus on the heaviest cost of living rise since British records began (1950s), the market still prices the BoE Bank Rate at 2.20% at the December meeting later this year,” says Franceso Pesole, a strategist at ING.

“That pricing of the BoE cycle is likely keeping GBP relatively well bid, although we do think the risks are growing of Cable breaking down to the 1.25/28 area over coming months,” Pesole and colleagues said in a Monday note.

Above: Pound to Dollar rate shown at weekly intervals with Fibonacci retracements of 2020 recovery indicating possible areas of medium-term technical support for Sterling. Shown alongside GBP/USD’s 200-week moving-average.

The market’s pricing-in of the anticipated Federal Reserve interest rate cycle has lifted U.S. bond yields relative to those in the UK and weighed heavily on the Pound to Dollar exchange rate, although the Fed’s pending effort to shrink its balance sheet will also lift U.S. bond yields further.

For Sterling the danger is that this Wednesday’s outline of the Fed’s plan for quantitative tightening reveals a process that will be faster than financial markets have envisaged, which would potentially be a negative surprise for the Pound-Dollar rate.

“The markets showed support for price at 1.30 in March and we presume this is a level buyers may defend until something fundamental/macro changes to weaken GBP,” says Paul Ciana, chief technical strategist at BofA Global Research. 

The Pound-Dollar rate will also listen closely on Monday and Thursday to scheduled speeches from BoE Governor Bailey, Deputy Governor Sir John Cunliffe and chief economist Huw Pill, and could be sensitive to any further suggestions that market expectations for Bank Rate have become excessive.

Sterling may also be susceptible to any risk aversion or other fallout resulting from allegations of Russian atrocities in Ukraine including an alleged massacre of civilians in the reclaimed town of Bucha, which prompted international condemnation on Monday and drew calls for further G7 sanctions.