GBP/USD Week Ahead Forecast: Looks to Hold 1.20 but Risks 1.18

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The Pound to Dollar exchange rate has stubbornly recovered the 1.20 handle but faces a battle to hold onto it in the days ahead during which it will be at risk of a slide toward the round number of 1.18 and may have difficulties in extending any further advance far above the 1.21 level. 

Pound Sterling fell briefly below the 1.19 handle last week before pulling off a stubborn recovery of 1.20 ahead of the weekend thanks in part to a U.S. Dollar that slowed in its climb from midweek onward and due to the market response following the Prime Minister’s resignation last Thursday.

“We should not assume that political developments are the dominant driver for GBP in the FX markets. Plenty of other factors are likely to prove more important going forward,” says Lee Hardman, a currency analyst at MUFG.

“We maintain a bearish view for GBP and in the likely scenario of EUR/USD breaching parity soon, GBP/USD will likely extend to new lows beyond the 1.1876 low recorded this week,” Hardman warned in a Friday research briefing. 

Above: Pound to Dollar rate shown at hourly intervals with Fibonacci extensions of Tuesday and Wednesday’s lurches lower indicating prospective pivot points for Sterling in the short-term. Click image for closer inspection. 

It is most notable for the Pound to Dollar rate, however, that despite its new highs the U.S. currency has been unable to sustain for long the erratic bouts of strength that continue to characterise its breakout to new multi-year, if not multi-decade highs against many major currencies.

“A strong and above consensus payrolls report offers a reminder that the US is still on a firm footing. While a recession is likely, the timing could be much further out than the market,” says Mazen Issa, a senior FX strategist at TD Securities. 

“USD strength this week has come off the back of a breakdown in EUR, so some position squaring could see some minor reprieve. But we think this is short-lived given upcoming CPI and CIE numbers. And, without a positive EUR offset, the USD remains king of FX,” Issa and colleagues said on Friday.

The Dollar did not make much of the brief rally that followed on Friday when June’s non-farm payrolls report emerged much stronger than was expected by the market and in the process echoed the suggestion of other U.S. economic figures released last week. 

Above: Pound to Dollar rate shown at 4-hour intervals with Fibonacci retracements of July and mid-June declines indicating possible areas of short-term technical resistance for Sterling and support for the Dollar. Click image for closer inspection.

“The noncession in the first half of the year doesn’t mean that the coast is clear. The most interest-sensitive sectors, including housing, are part of the Q2 softness, and the Fed is bent on turning up the pressure by taking the funds rate through 3%. Revised data on consumption show that Americans squeezed by prices running faster than wages are being forced to slow their spending,” says Avery Shenfeld, chief economist at CIBC Capital Markets. 

“But this noncession, and a parallel slowing globally, may have opened the window a bit for the Fed to back away from its most hawkish projections, after what’s likely to be another 75 basis point hike this month. The minutes of the last FOMC meeting, at which the “dots” for further rate hikes were dramatically escalated, already look out of date in their references to a pickup in growth and consumer demand,” Shenfeld added on Friday.

While the U.S. Dollar Index did rise during the Asia session on Friday, it made little headway in comparison to prior gains and had already effectively stalled in the wake of Wednesday’s Institute for Supply Management (ISM) Services PMI. 

This fell less than expected by the market and was one of numerous recent indications that the U.S. economy may be on a firmer footing than the market has recently given credit for, which may mean that widely held concerns about the risk of a U.S. recession have reached a crescendo.

Above: U.S. Dollar Index shown at monthly intervals with Fibonacci retracements of 2002 downtrend indicating medium and long-term resistances while featured alongside 02-year and 10-year U.S. government bond yields. Click image for closer inspection.

That would be supportive of the Pound and more so if the Dollar is unable to capitalise on Wednesday's inflation data, which cannot be ruled out given that it did not benefit either when Atlanta Federal Reserve President Raphael Bostic told CNBC News that interest rates need to rise more than previously thought.

He has so far been among the most moderate members of the Federal Open Market Committee but Friday's remarks placed him into closer alignment with Christopher Waller and James Bullard who're recently called for the Fed to lift interest rates to 2.5% in July and 3% in September.

"The Fed’s decision will be shaped by data over the next couple weeks; we hope the core price data, alongside relatively soft retail sales, industrial production, and housing data, will persuade policymakers that a further 75bp hike is unnecessary; 50bp is more than enough," says Ian Shepherdson, chief economist at Pantheon Macroeconomics.

Wednesday’s inflation data is the highlight for the greenback this week but Thursday's first-quarter GDP data from China may impact market risk appetite and many currencies  while on the other side of the Pound-Dollar equation, Sterling's attention will be on a Tuesday speech from Bank of England (BoE) Governor Andrew Bailey. 

"We expect BoE policy tightening to remain at more cautious +25bp increments in the remainder of this year (the ~150bp of Bank Rate tightening priced in by year end continues to strike us as very aggressive)," says Ross Walker, chief UK economist at Natwest Markets.

Above: Pound to Dollar rate shown at weekly intervals with Fibonacci extensions of mid January to mid March downtrend indicating prospective short or medium-term pivot points. Click image for closer inspection.

"We are, however, modifying our Bank Rate forecast: we continue to expect +25bp to 1.5% in August (with only modest risks of +50bp) but bring forward our forecast for subsequent 25bp rises to November 2022 to 1.75% and February 2023 to 2.0% (previously February & May 2023)," Walker also said on Monday. 

The governor is set to speak at an Official Monetary Institutions Forum (OMFIF) event that will be followed by Wednesday's release of GDP data for May, which could help Sterling if it shows an economy holding up better under the weight of onerous energy prices than is anticipated.

The consensus among economists looks for 0% growth to follow on from April's -0.3% contraction and any upside surprise might be enough to prevent the question mark over financial market assumptions about the BoE interest rate outlook from growing any larger. 

"A larger than expected fall can push GBP/USD to test downside support at 1.1876," says Joseph Capurso, head of international economics at Commonwealth Bank of Australia. 

"We now expect the Bank of England (BoE) to increase the bank rate by 50bp on4 August (25bp previously expected).  The UK’s labour market is very tight, wages growth is strong and inflation expectations are high and rising," Capurso and colleagues said on Monday.