GBPUSD Grapples with Uncertain Recovery Prospects

"The chart shows that markets’ expectations for the peak level of Bank Rate have come down a bit," Pantheon Macroeconomics. 

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The Pound to Dollar exchange rate entered the final session of the week steadier on its feet after testing a major level of technical support on the charts previously but its recovery prospects are undermined by a deteriorating economic outlook while the outlook would become bleaker still if interest rates rise further in the months ahead.

Sterling was stronger against most major currencies on Friday after reversing widespread losses on Thursday when the Institute for Supply Management reported "a slight pullback in the rate of growth for the services sector," but an otherwise resilient performance from the world's largest economy. 

Dollar losses helped the Pound to recover a major level of technical support near the round number of 1.26 on the charts after Thursday's Bank of England (BoE) raised Bank Rate from 5% to 5.25% in a monetary policy decision that left some analysts, economists and financial markets underwhelmed.

"We are probably now at a stage where we can be thinking about the peak in rates, but the Bank is retaining flexibility to go higher if necessary. Nonetheless, the length of time that rates stay at their peak is more important than the actual level itself," says Neil Birrell, chief investment officer at Premier Miton Investors. 

Of note and alongside Thursday's decision the BoE announced new forecasts for inflation modelled on the assumption that Bank Rate is likely to rise further from the current level, to around 5.75% and its highest point since the late 1990s before being held there for as many as three years into the future.

Above: Pound to Dollar rate shown at daily intervals with Fibonacci retracements of selected uptrends indicating possible areas of technical support for Sterling. 

Meanwhile, other forecasts suggested an unchanged pace of economic growth going into year-end following "underlying" growth of 0.2% in the opening half of the year but with past increases in Bank Rate expected to weigh increasingly on the economy as time goes on, the outlook is arguably uncertain.

"Economic activity has shown some unexpected resilience over recent quarters. But the increases in Bank Rate we have implemented weigh to an increasing degree on UK economic activity. There is evidence that monetary policy is restrictive," Governor Andrew Bailey said of new forecasts accompanying the decision on Thursday.

The BoE noted in its monetary policy announcement that it had observed signs of "less resilient growth, and lower consumer confidence," during July while Thursday's reported difficulties at national discount retailer Wilkinson offered another sign of a quickly deteriorating economy.

"Given Ofgem’s price cap on electricity and gas bills – and the way it slows down the passthrough of wholesale energy prices to consumer bills – we expect inflation to take a further step down in July’s data published in two weeks’ time, to around 7%, followed by another larger step down in October’s data," the governor told a press conference. 

Mercifully for mortgaged borrowers, expected falls in household energy bills are on course to cushion the economy somewhat over the second half of the year while also offering buyers and holders of UK government bonds their first glimpse of a 'real,' inflation-adjusted or otherwise capital preserving return. 

Source: Pantheon Macroeconomics. 

"The chart shows that markets’ expectations for the peak level of Bank Rate have come down a bit, after the Committee opted for a 25bp, instead of 50bp hike, today," writes Samuel Tombs, chief UK economist at Pantheon Macroeconomics, on Thursday. 

Wholesale energy prices have fallen notably this year but the machinations of the UK government energy price cap have kept those declines from being passed onto households, some of whom are now grappling with crippling increases in mortgage costs, the burden of which might be eased by lower household energy bills

Any glimpse or glimmer of an inflation-adjusted or capital-preserving return is potentially a supportive factor in the outlook for Sterling even if and when the economy begins to weaken, which might help the Pound to Dollar rate remain supported near and around current levels, but much depends on the how the market reacts to forthcoming UK economic data.

"GBPUSD peaked at its long-term trend line in the 1.31s and until it breaks through this it could be a medium-term turning point," says Paul Ciana, chief technical strategist at BofA Global Research, in a Thursday research briefing. 

"The one-week rally above the 200wk SMA has been reversed suggesting a false break. Stretched momentum (overbought conditions) has begun to turn down. Downside to 1.2690 / 1.25 possible while price is below the red resistance line, " he adds. 

Source: BofA Global Research.