GBP/USD Week Ahead Forecast: Recovery Crimped as Headwinds Emerge

• GBP/USD at risk of deeper corrective losses short-term
• Market pricing of Fed & BoE policy outlook a headwind
• But technical support possible around 50-day average
• Fed speaches, debt ceiling & retail sales eyed by USD 
• UK's wage figures & BoE testimonies in focus for GBP 

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The Pound to Dollar exchange rate beat a retreat from its highest level for more than a year last week but economic headwinds on both sides of the equation now risk seeing it sidelined into a further consolidation.

Sterling neared 1.27 last week before falling at the final furlongs after official figures warned of a weak finish to the first quarter for the UK economy just as data from the U.S. helped the Dollar to stage a comeback on Friday

Dollars were bought widely when a jump in unemployment-related welfare claims and hawkish remarks from some Fed policymakers were followed up by a University of Michigan survey suggesting consumers' expectations for long-term inflation reached their highest since 2011 last month.

"The increase in inflation expectations will cause some alarm inside the FOMC. Michelle Bowman, a FOMC voter, indicated US interest rates may need to increase further if inflation and the jobs market do not cool more," says Joseph Capurso, head of international economics at Commonwealth Bank of Australia. 

"Too many FOMC rate cuts are priced for the near term in our view. We expect the FOMC to start cutting the Funds rate in January 2024, not September 2023 as per market pricing," Capurso and colleagues write in a Monday research briefing. 

Above: Pound to Dollar rate shown at 2-hour intervals alongside other selected pairs. 

Friday's survey could be of concern to the Fed because central bankers believe that rising inflation expectations can raise actual inflation through their effect on corporate pricing intentions and the wage bargaining behaviour of workers

This matters for the Dollar because it's a further indication of interest rate market investors and traders being mistaken for betting of late that the Federal Reserve is likely to cut its interest rate before year-end.

"Nobody we have talked to expects the Fed to cut rates this year, despite market pricing, but the strong majority still expects cuts next year.," says Athanasios Vamvakidis, head of FX research at BofA Global Research.

"Maybe we may see some USD strength once the market prices out the cuts this year, but the rally should be contained if the cuts are just pushed to early next year," Vamvakidis and colleagues write in a Friday research summary.

Market pricing has suggested for a while that as many as three cuts to interest rates are likely this year, weighing on the Dollar while helping the Pound to reach some of its best levels since April 2022 along the way.  

Above: Quantitative model estimates of ranges for selected pairs. Source Pound Sterling Live.

The risk is now, however, that Fed officials further discourage market assumptions about interest rate cuts from the speaking circuit this week with potentially adverse effects on Sterling, which must also navigate a gauntlet of domestic risks.

These include April employment figures out on Tuesday and a busy line-up of appearances from Bank of England (BoE) rate setters including testimonies to the Treasury Select Committee regarding last week's interest rate decision on Thursday.  

This is also after the BoE said "tightness of labour market conditions and the behaviour of wage growth and services price inflation," will inform future policy decisions, heightening the importance of Tuesday's data.

"It is not difficult to make a case for rates having already peaked if next week’s CPI data show the expected sharp decline in headline inflation," says Adam Cole, chief FX strategist at RBC Capital Markets, in a Monday note advocating that clients bet on a further decline in GBP/USD this week.

"The hurdle is high for this week’s labour market data pushing market pricing higher," he adds while tipping the Pound for a fall to 1.2250 up ahead.

 Above: GBP/USD at daily intervals with 50-day moving average and other selected pairs. 

Many in and around the market might also pay attention to congressional negotiations over the U.S. debt ceiling though it's not clear what effect they could be expected to have on the Dollar just yet. 

"House Speaker Kevin McCarthy will this week meet with President Biden to attempt to nut out a deal on raising the US debt ceiling. The meeting is slated to occur tomorrow, and is looking more and more like last chance saloon," says Benjamin Picton, a senior macro strategist at Rabobank. 

Debt ceiling negotiations are an annual occurrence but have been complicated this time out by an exceptionally polarised political environment and the administration's loss of its congressional majority last year. 

It's estimated that lawmakers have until month-end to strike an agreement before forcing the government to choose between a technical default and a partial shutdown involving the temporary furlough of public sector employees, which would be a further blow for an already-slowing economy. 

"The loss of US financial credibility would clearly be dollar-negative. The world’s reserve currency, whose position as such in the global financial architecture had come under question, would suffer a blow," says John Velis, an FX and macro strategist at BNY Mellon. 

Above: GBP/USD at weekly intervals with other selected pairs.