- The GBP/USD exchange rate may remain under pressure amid a potential UK interest rate cut and Friday’s US jobs report.
- Ahead of these important and influential events, the GBP/USD rate is holding around 1.2810 at the time of writing, its lowest in over two weeks.
According to the economic calendar, the Bank of England decision this week will be the main focus for the pound, and the market is currently split 50/50 on whether the bank will go ahead with a rate cut. The heightened uncertainty means that markets will be sensitive to the outcome, and as such, we could see some high volatility this week.
Our general outlook for this week is for weakness in the near term as traders position themselves for potential volatility. Thus, this caution could reflect GBP/USD weakness, and a pullback towards 1.28 cannot be ruled out in the near term. A pullback to this level is likely to be more likely if global equity markets continue to struggle; last week we saw the pound come under pressure amid a broad sell-off in equity markets, a reminder that the exchange rate is sensitive to broader sentiment.
Currently, financial markets are pricing in just over a 50% chance of a rate cut on Thursday. Sterling’s weakness last week certainly reflects a rebuilding of this expectation, with the odds of a cut now closer to 40%. Also, the market has built up a record long position in sterling over recent weeks as investors look for further outperformance. Meanwhile, the risk is that this crowded positioning will be eroded by any disappointment, exposing sterling to a deeper pullback. Even in the case of a hawkish cut, we tend to think that markets will continue to sell sterling on a cut as positions are pared back, a “hawkish cut” being when the Bank cuts interest rates but signals to the markets that further cuts are not guaranteed and are dependent on upcoming economic data.
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But what if the Bank does not cut rates?
This could provide some upward relief for the GBP, which could rebound towards the end of the week, especially if the US jobs report on Friday falls short of expectations. However, the rise in GBP/USD is likely to be limited as the bank will surely “pave the way” for a rate cut in September. According to analysts at Oxford Economics, "the conditions are ripe for the MPC to cut, but we think it will wait until September to avoid surprising the markets." A strong commitment to a rate cut in September would make this a “dovish hold,” which does not entirely align with a GBP recovery.
Beyond short-term weakness prospects, Bank of America sees the structural backdrop still supportive for the GBP: “Excluding event risks and with the new government in a hurry to announce policy, we look for further GBP appreciation in the coming months. Asset investment remains supportive, but near-term positioning is crowded.”
Furthermore, this fits into the broader theme of near-term weakness before a resumption of the rally sometime in the coming weeks.
A big week for the US Federal Reserve
Turning to the US dollar, the Federal Reserve is expected to release its policy decision on Wednesday. No change in US interest rates will be made. Instead, we expect a dovish tone in line with expectations for the first rate cut in September. Concurrently, the market is now “fully priced in” for such an outcome, meaning the US dollar will rally if the Fed casts any doubt on the launch of a rate-cutting cycle in September. Moreover, we expect the Fed to continue its new strategy of highlighting concerns that keeping rates on hold for too long could be detrimental to the labor market.
This aligns with the Fed’s statement that it believes it can afford to cut interest rates before inflation falls back to its 2.0% target. Decisively, the most important event for the US dollar comes on Friday when the US jobs report is released. If the data comes in below expectations, the market will price in further policy easing from the Fed in the coming months, which will weigh on the dollar.
Technical forecasts for the GBP/USD pair today:
We believe that any weakness in the GBP/USD from here could lead to a decline in the exchange rate back to the 1.2760 area. Technically, this aligns with the 38.2% Fibonacci retracement of the April to July rise and considers the 50-day moving average (DMA) at 1.2780. The 50-day moving average halted the decline in June, where the uptrend was confirmed again.
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