GBP/USD Rate's Relief Rally

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The Pound to Dollar exchange rate is rising as it unwinds some of the recent selloff, but the bigger picture remains one consistent with ongoing weakness.

Pound Sterling recovered through Tuesday thanks to a stronger-than-expected UK PMI report that showed the economic rebound accelerated in April, while a key member of the Bank of England gave a speech that cooled a recent rise in market expectations that interest rate cuts were close at hand.

The Bank's Chief Economist Huw Pill warned that nothing had changed with regards to the Bank's stance on interest rates and that there is a larger risk of easing monetary policy too early than too late.

The Dollar was meanwhile left underwhelmed by a U.S. PMI survey that printed at its weakest in four months, raising hopes that the disinflation narrative in the U.S. is not completely dead.

"Markets have pushed back slightly against the policy divergence view that has catapulted the US dollar higher this year. Although there is plenty of evidence that the US economy continues to outperform its global peers, S&P Global’s business activity data, released yesterday, saw US activity expanded in April at the slowest pace in four months," says George Vessey, Lead FX Strategist at Convera.

Following the data, money market pricing showed investors now see two 25 basis point rate cuts by the Federal Reserve this year, sending U.S. yields and the U.S. dollar lower.

"GBP/USD has recovered well over a cent from Monday’s 5-month low around $1.23, though it’s still caught in a downtrend channel that’s been in place since mid-March," says Vessey.

What happens to U.S. rate cut expectations from here will ultimately determine the direction of the Dollar, with most analysts warning that further strength is likely.

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An analysis from ING Bank finds further Pound-Dollar "underperformance is certainly the near-term risk". Chris Turner, a currency strategist at ING says he expects the greater differentiation between the Bank of England and Fed rate cutting cycles will "particularly weigh on GBP/USD".

The Bank of England looks set to cut in either June or August, which is before the Fed will. Joseph Capurso, an analyst at Commonwealth Bank, points out that some market analysts are now talking up the prospect the Fed will increase interest rates again after a long period of stability.

CBA still expects the next move to be a cut but warns if the Fed does hike it will do so at least twice.

"A resumption of hikes would obviously support the USD because hikes are not priced," says Capurso.

ING's Turner says a further fall in the U.S.-UK interest rate differential, on account of Bank of England rate cut bets increasing, will favour further Pound-Dollar weakness.

"At an extreme, say 50bp, swing in the GBP:USD one-year swap differential in favour of looser BoE policy, the relationship since the start of 2023 suggests GBP/USD should be trading closer to 1.21. In short, it looks like some further sterling under-performance is certainly the near-term risk," says Turner.