GBP/USD Week Ahead Forecast: Test of 1.25 Possible if Recovery Extends

Modified: Monday, 16 May 2022 06:51 BST
Written by: James Skinner

GBP/USD’s recovery could be set to extend
If markets cheered by Shanghai’s reopening
But BoE policy, UK data could limit rebound
Fed Chair speech & U.S. data also in focus

Image © Adobe Images

The Pound to Dollar exchange rate has deepened an almost year-long downtrend but could attempt a corrective rebound this week if an easing of coronavirus-related restrictions in Shanghai is welcomed by global markets.

Pound Sterling had fallen to a fresh two year low against the Dollar last week when the greenback climbed alongside rising investor concerns about the outlook for the global economy and as China’s influential Renminbi extended an April sell-off through its sixth week.

This price action helped lift the Dollar Index to its highest level since soon after the turn of the new millennium before the global market tide turned in favour of Sterling late in the European session on Friday, in the process lifting the Pound to Dollar rate back above 1.22 ahead of the weekend.

Fortunately for Pound there may now be scope for that rebound to extend after authorities in China announced at the weekend that Shanghai would begin a phased reopening from the country’s most severe ‘lockdown’ so far in what is a potentially meaningful filip for market sentiment.

“Up to 25% of US dollar strength vs. DM currencies (DXY and the bulk of BBDXY) can be attributed to the deterioration in China sentiment,” says Adarsh Sinha, head of Asia-Pacific FX strategy at BofA Global Research in Hong Kong.

Above: Pound to Dollar rate shown alongside Renminbi-Dollar rate and Euro-Dollar rate. Click image for closer inspection.

“In the case of EM FX, a larger proportion of its depreciation vs. USD - closer to half - can be attributed to the China factor,” Sinha and colleagues also said last week in summary of findings from recent statistical analysis.

China’s April shutdown of Shanghai has been a significant source of market risk aversion over the last six weeks because the city is home to the country’s largest seaport, which is also the world’s most important due to its significance in international supply chains and goods manufacturing.

This is why the reopening could act as a headwind for the safe-haven Dollar and a tailwind to many other currencies that would imply an extension of Friday’s Pound to Dollar exchange rate rebound, although Sterling would meet technical resistance on the charts once back at 1.25 or above. (Set your FX rate alert here).

“Worsening economic risks with the UK’s cost-of-living crisis have sharply impacted the GBP mood alongside broad gains for the dollar and risk aversion,” says Juan Manuel Herrera, a strategist at Scotiabank.

“With the BoE possibly pausing at one of its upcoming meetings while the Fed continues with its aggressive hiking schedule, the GBP is at risk of testing 1.20,” Herrera and colleagues said in review of the outlook for Sterling last week.

Above: Pound to Dollar rate shown at daily intervals with Fibonacci retracements of February and April declines indicating prospective areas of technical resistance for Sterling and support for the Dollar. Click image for closer inspection.

While the Pound-Dollar rate could benefit from a robust start this week the danger is that Monday’s parliamentary testimonies from Bank of England (BoE) policymakers, or the subsequent deluge of economic data including UK employment and inflation figures later dampens appetite for Sterling.

“There is downside support at 1.1959. The path of least resistance for the GBP is down,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.

“Friday’s retail sales for April will be monitored for further signs that consumers are cutting back on spending in the wake of very high inflation, rising interest rates and uncertainty around the war,” Capurso and colleagues said on Friday.

This week’s remarks from BoE policymakers and subsequent data could ultimately ensure that any further recovery in the Pound to Dollar exchange rate is muted overall, while also potentially leading to underperformance by Sterling relative to other currencies.

But much also remains to be determined by market appetite for the Dollar, which has benefited significantly from a deteriorating global economic outlook that reflects ‘lockdowns’ in China, the continued elevation of inflation rates around the world and Federal Reserve (Fed) monetary policy.

Above: U.S. Dollar Index shown at monthly intervals with Fibonacci retracements of 2001 and 2003 downtrends indicating prospective areas of medium and long-term technical resistance to a further recovery.

Inflation is squeezing household incomes and pushing central banks around the world into a corner within which they have few good policy choices.

“I just came back from a set of meetings with central bankers from around the world, and we’re all facing the same kind of issues and the public are facing the same kinds of issues,” Fed Chairman Jerome Powell said last week in an interview with Marketplace Radio.

“I would say that we fully understand and appreciate how painful inflation is, and that we have the tools and the resolve to get it down to 2%, and that we’re going to do that. I will also say that the process of getting inflation down to 2% will also include some pain,” he added in the Thursday discussion.

This is why the market is likely to pay close attention to Fed Chairman Jerome Powell when he speaks about the subject of inflation at The Wall Street Journal Future of Everything Festival in New York this Tuesday.

His appearance is scheduled for 19:00 London time and comes ahead of various appointments for other Fed policymakers as well as the Wednesday release of U.S. retail sales figures for April, which are also likely to be scrutinised closely by the market.

“In any case, the data are unlikely to change the outcome for the June FOMC meeting; Powell has already signalled a 50bps hike in June (and July). Officials will also have another CPI report (June 10) ahead of the FOMC meeting,” says Kevin Cummins, chief U.S. economist at Natwest Markets.