GBP/USD Looks to 1.34 Next

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The British Pound extended its rally against the U.S. Dollar, but month-end flows and overbought conditions could prompt a pullback in the coming days.

The Pound to Dollar exchange rate (GBP/USD) is expected to secure its fifth consecutive daily gain on Tuesday, helped by a buoyant global investor backdrop and fresh comments by Bank of England Governor Andrew Bailey.

He reiterated the Bank's message from the previous week's policy decision that interest rates will likely fall from here but at a slow pace.

"I do think the path for interest rates will be downwards, gradually," he told Kent Online.

Asked whether British households would again see rates near zero again, Bailey said "I would not expect" that "because what caused interest rates to go that way it was, amongst other things, two very big shocks to the economy."

"It all started with the financial crisis then Covid was another big shock," he adds.

The Bank of England is in the slow lane when it comes to cutting rates, whereas the U.S. Federal Reserve looks comfortable getting on with the job and lowering rates to a level that it thinks is no longer restrictive, nor would it be stimulatory.

Investor sentiment meanwhile remains buoyant, which traditionally supports GBP/USD.

"There is no tier 1/2 data left on the calendar for the week so GBP crosses will likely trade in line with its beta to risk over the remainder of the week," says Noah Buffam, an analyst at CIBC Capital Markets.

Stock markets rallied on Tuesday thanks to a major stimulus announced by China. The central bank cut its main interest rates while lowering regulatory restraints on mortgages.

Economists say the latest package was more generous than the market was expecting, giving hope that it can stimulate global demand. This is bullish for stocks and commodities and is ultimately supportive of GBP/USD.

The next level being targeted by GBP/USD 'bulls' is the 1.34 round figure; however, we note that the exchange rate is reaching technically overbought levels.

The daily Relative Strength Index has kissed the 70 level, suggesting momentum is still strong, albeit now overbought. The RSI rarely stays at 70 or higher, meaning either consolidation or a decline will occur in the coming days.

"We think GBP may be a little stretched at these levels, though any GBP weakness may have to wait, given the stickiness of UK inflation data," says Clyde Wardle, Senior EM FX Strategist at HSBC.

Volatility can rise in the coming days as the end of the month and the quarter is approaching, which will require global portfolio managers to rebalance their currency exposure. This can create seemingly random flows that generate volatility in either direction.

"I would be surprised if we end up with enough USD selling for quarter end to push us through 100 support in DXY, generally the quarter ends have been USD positive, so if anything, we are likely to grind back above 101 towards 102," says Brad W. Bechtel, an analyst at Jefferies.

Looking further ahead, the major risk to GBP/USD would be a more rapid slowdown in the UK economy that would encourage the Bank of England to slash interest rates.

"A number of forward looking indicators are now suggesting that prices, wages, and growth are easing and if the hard data follows we could see BoE pricing shift towards a quicker return to neutral. As a result, we like GBP shorts against currencies which are priced for a more aggressive easing cycle," says Buffam.