GBP/USD Rate: Key U.S. Inflation Release Dominates Near-term Outlook

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The Pound to Dollar exchange rate (GBP/USD) will look to the release of U.S. inflation data on Thursday to further underpin its multi-week rally, with a softer-than-expected reading potentially even allowing for fresh highs to be tested.

U.S. data is firmly in the driving seat, not just of GBP/USD, but all Pound exchange rates, owing to the UK currency's ongoing positive correlation with global investor sentiment.

U.S. CPI inflation data is due at 13:30 GMT, month-on-month growth is expected to be at 0%, year-on-year at 6.5%, down on December's 7.1%.

Should inflation come in below expectations then the Pound could benefit and extend higher against the Dollar, but a stronger-than-expected number could boost the Dollar and deal a setback to GBP/USD which could decline below 1.20 again.

Markets could however choose to place a greater emphasis on core inflation which is expected to print at 5.7% year-on-year for December, which would be a further slowdown from the previous reading of 6.0%.

"Unless the core measure significantly surprises to the upside, USD rallies should be sold into. We think the bar is high to compel a reversal of fortune despite the USD tactically stretched," says Mark McCormick, Global Head of FX Strategy at TD Securities.

It was a below-expectation inflation release in November that set currency markets on fire and prompted a sharp decline in the Dollar as investors bet peak inflation had been reached, triggering a rally in GBP/USD that ultimately took it back to the 1.20 level.

December's U.S. inflation reading also came in below expectation and underscored the GBP/USD updraught as investors became more confident that the Federal Reserve could soon afford to rest from its interest rate hiking cycle.

This pushed U.S. bond yields lower, easing monetary conditions and boosting risk-sensitive assets such as stocks and the Pound.

It was a rise in yields through 2022 that proved a major source of support for the Dollar as it attracted foreign investor inflows into U.S. bonds and sunk stock markets which provided further support for the safe-haven Dollar.

But analysts expect 2023 to see the Dollar give back some of its gains as the Fed dynamic turns.

"The market has moved back to fading Fed hawkishness by bringing forward cuts this year and putting the USD on the back foot. An on-consensus print does not strike us as a particular threat to the latter especially since the market seems rather content to trade on peak inflation and China re-opening," says McCormick.

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"Moreover, it is not evidently clear that a positive surprise on core inflation would tremendously alter the path for the USD either," he adds.

If McCormick is correct, then any GBP/USD weakness following a stronger-than-expected inflation reading might prove fleeting in nature.

Research from TD Securities finds the Dollar's correlation with the Federal Reserve's funds curve has been neutralised following the Bank of Japan's YCC shift.

The BoJ recently said it would ease its policy of keeping Japanese bond yields under control, signalling one of the world's most influential central banks was finally preparing to walk away from a multi-year policy of suppressing interest rates.

TD Securities finds the Fed is no longer in a leadership position on policy, and it is not clear that a stronger CPI would wrestle it away from the ECB and BoJ.

"The USD's correlation to data surprises has weakened again after a brief revival. As much as the USD looks stretched on a tactical basis, we think the bar is high to compel a reversal of fortune," adds McCormick.

If correct, this should translate into a high bar being put in place for a major reversal in the Pound's fortunes against the Dollar.

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