GBP/USD Conversion on Target for May Highs

The savage sell-off witnessed on the pound to dollar exchange rate pairing following the release of inflation data on Tuesday proved to be short-lived and an attempt to test May highs has since taken place.

"Resistance is now likely at 1.586 or so, at which point sterling will have retraced 50% of the previous decline." - Charles Stanley.

In the wake of news that the UK had slipped into deflation, for the first time since 1960, sterling quickly slunk to support at the 1.55 level against the dollar. This level was significant as we thought there would be enough buying interest at this discounted price to arrest declines.

We also mentioned that we thought any weakness in the British pound exchange rate complex owing to the deflation news would ultimately be short-lived as the Bank of England have warned inflation will start increasing again towards the year end.

Had sterling broken the strong 1.55 support the gates would have been left be wide open for 1.54 and then 1.52 to be taken out. This did not occur, but should a new GBP sell-off occur this prediction remains valid. Instead, support has held and there are signs that sterling-dollar could be about to attack recent highs once more.

While the pound sterling remains favoured at the present time the US dollar continues to struggle with markets unconvinced that the US economy is growing at the speed needed to support a rising dollar exchange rate complex. “It still remains to be seen whether this is just a move lower in a range or if we are resuming a downward trend. For the time being we remain cautious and maintain a neutral stance with minimum positioning,” say Goldman Sachs in a strategy note on the GBP-USD to clients.

Keep in mind that all quotes in this article reference the inter-bank spot rate. Your bank transfer will affix a spread at discretion. Independent providers are however able to get you closer to the spot market rate, in some cases this can deliver up to 5% more currency. Find out more.

How High can the GBP-USD Climb?

Also urging caution at the present time is analyst Bill McNamara at Charles Stanley who points out that the sterling to dollar exchange rate is now potentially overbought:

“Last week I noted that sterling looked like it had further to run relative to the dollar and that if the January peak at 1.55 was successfully negotiated we would probably see a continuation of the rally up to 1.575. Last week’s closing high was 1.5774 and although the pound continues to display strong upside momentum it is worth highlighting the fact that this strength has also left it looking relatively overbought.

“Consequently, resistance is now likely at 1.586 or so, at which point sterling will have retraced 50% of the previous decline.”

Longer-Term - be Wary of the US Dollar Return to Strength

The dollar basket (a combination of all the major US dollar based currency pairs) has fallen by around 6% over the course of the past 4-5 weeks. Despite the recent weakness there remains an almost unanimous view amongst those institutions we follow that US dollar strength will make a return.

“The Fed is in no rush to hike rates due to weak U.S. data. USD short-term consolidation may continue. However, in the medium and long term, the USD uptrend may resume as current USD cumulative increases are still lower than the historical average,” warn Citibank in Hong Kong in a currency research note released on the 18th of May.

It would appear then that the USD return-to-form story remains a question of timing - i.e. at what stage do we call an end to the pound v dollar exchange rate’s climb or will the pound itself become the ‘new US dollar’ in which case it could keep on climbing?

Michael Stanes, Investment Director at Heartwood Investment Management, says he believes the worst of the run of poor US economic data releases has passed us, and he believes that the Federal Reserve will be the first central bank in the G4 to raise rates, which should favour a stronger US dollar trend over the longer term.

However, sterling is looking good too and has enjoyed a post-election bounce with currency markets deciding to overlook the Bank of England’s revision lower of growth forecasts this year. UK rate expectations have been pushed back to the second quarter of next year though which could weigh on the outlook.

In the near-term we continue favour the GBP as it has the benefit of momentum in its sails, while we remain uncertain as to just how much the UK unit will be hurt by a return to strength by the dollar.

“For the GBP, since the Conservative Party won a majority, clearing uncertainty and upbeat U.K. job data came in, the GBP may rise to 1.63 for the coming 0-3 months. However, the GBP may test lower to 1.47 for the coming 6-12 months as the U.S. may hike rates earlier than the U.K,” say Citigroup confirming they see weakness ahead in the longer-term timeframes.