GBP/USD: "The Damage is Already Done" says City Index's Razaqzada

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The ongoing appreciation in the U.S. dollar triggered a significant breakdown in the EUR/USD and GBP/USD exchange rate pairs in the previous week and analyst Fawad Razaqzada of City Index is eyeing further weakness.

At the start of this week, the Pound to Dollar exchange rate was seen to stage a small bounce to 1.2410 amid profit-taking ahead of this week's key macro events.

"But the technical damage is already done, with rates closing below the 200-day average on both Thursday and Friday," says Razaqzada in his most recent analysis of the pair.

"So, watch out for renewed weakness in the cable as it tests key resistance here around 1.2400 (give or take a few pips), which was previously support," he adds.

Above image courtesy of City Index.

Much like the EUR/USD, the GBP/USD could take out its corresponding low made in May at 1.2308 next says the analyst, below which there are not many obvious reference points apart from the round figures like 1.22, 1.21 and possibly even 1.20 next.

"Given the growing bearish momentum, the bulls must wait for a key reversal pattern to emerge before potentially looking for bullish trade ideas," he adds.

Sterling's weakness against the Dollar comes at the head of a busy week for both sides of the Dollar and Pound equation, which starts with the release of inflation figures Wednesday at 07:00 BST.

CPI is expected to continue dropping rapidly in the next few months due to base effects. For August, however, it is seen rising back to 7.1% y/y from 6.8% in July. Core CPI is expected to print 6.8% compared to 6.9% the month before, while RPI is seen rising to 9.3% from 9.0% previously.

"Inflation now needs to come down fast to arrest this price-wage spiral before it gets out of control. Last month, CPI did fall sharply from the 7.9% y/y recorded in June, albeit to a still-very-high 6.8% in July," says Razaqzada.

FOMC Decision

Strong U.S. inflation numbers and surprising strength in some other key parts of the world’s largest economy have given rise to speculation that the Fed’s tightening cycle may not be over just yet.

While no policy changes are expected at this FOMC meeting, traders will be looking for clues with regard to the next meeting.

"If there’s a strong inclination towards a final hike before the year is out, then this should support the dollar on any short-term dips," says Razaqzada.

He says to keep a close eye on the policy statement and the latest dot plots and hear what Powell says at the FOMC press conference.

The Fed may indicate that one more hike is likely before the year is out – thanks to a slower disinflation process that has undoubtedly been boosted by a stronger US consumer and higher inflation expectations. The FOMC may upwardly revise the 2024 median plot to point to fewer rate cuts than the 100 bps it had projected previously.

"If so, this would further discourage bearish bets on the dollar, keeping the pressure on the GBP/USD," says Razaqzada.

Bank of England

The recent weakness in the pound is a reflection of investors scaling back their hawkish BoE bets, thanks to weaker-than-expected UK data, explains Razaqzada.

Last week it was GDP which disappointed, raising recession alarm bells. But wage growth remains strong, which points to a pick-up in consumption. Is this something that will worry the MPC about the risks of a price-wage spiral getting out of hand?

"The BoE will have seen the latest CPI data that would be released the day before their rate decision. Given that economists expect an uptick in CPI from the month before, this is unlikely to discourage the MPC from voting for, what many expect, another 25-basis point rate increase to take the Bank Rate to 5.50%," says the City Index analyst.

The language of the Bank's statement will be key and analysts will watch to see whether it will drop the key phrase "If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required."

"If the BoE makes it clear that this is the peak like the ECB did last week by suggesting, for example, that rates are “sufficiently restrictive,” then this should hurt the pound. It is certainly what I am expecting anyway, and for that reason reckon that the GBP/USD could be heading to low 1.20s from here," says Razaqzada.