GBP sell-off looks over-done, especially after BoE minutes
It just seems to be getting worse for GBP, which is flirting with four month lows versus USD. However the sell-off is starting to look over-done with the UK economy still in robust shape and with dissension building at the Bank of England over interest rates.
Two factors have removed support for GBP. One is the recent dovish tone by the Bank of England over monetary policy and secondly the hawkish tone contained in the minutes released by the US Federal Reserve suggesting a US interest rate rise could happen sooner than anticipated.
However, the same holds true for UK interest rates. In the BoE's latest minutes two members voted for a 25 basis point rate rise reflecting signs of nervousness over future inflationary prospects.
True UK inflation and wage rises are both low, but given the strength of the UK's recovery (GDP growing at 3.2%), this could change quickly. Indeed, the rapid fall in unemployment is likely to soon see upward pressures on wages – something the two BoE dissenters appear to be anticipating.
Therefore, a modest 25bp rate rise – hardly enough to derail the strong recovery – could still happen by the end of the year. Also, anticipating inflationary pressure would make bigger interest rate rises less likely later on. The BoE has to be careful that by being too dovish it doesn't end up having to raise interest rates quickly to catch-up with the economy and end up creating a bust.
GBP/USD – hammered!
US recovery makes gains against USD harder
The US Fed is set to wind down its quantitative easing programme in October. The Fed also appears a lot more optimistic about the US economy and seems keen to normalise monetary policy soon.
Certainly, the US economy seems to have rebounded in the last quarter, the pace of jobs creation is strong and at least one member of the Fed is pushing for tighter monetary policy.
Though that makes it tougher for GBP to recover lost ground against USD – the pace of the sell-off looks over-done. Indeed, there should be some form of consolidation on GBPUSD shortly and possibly a recovery later in the year back to around 1.6700-1.6800.
After all the UK has shown itself to be consistently more vulnerable to inflation than the US – suggesting the BoE may have to be more aggressive than the Fed. GBP has also lost some ground to the EUR, which also looks over-done given the Eurozone's lack of economic growth and ongoing deflationary predicament.
By Justin Pugsley, Markets Analyst
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