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Speculation over Central Bank Rate Hike Odds Boosts GBP USD Exchange Rate

June 23, 2017 - Written by David Woodsmith

Ahead of the weekend the Pound US Dollar exchange rate remained on a bullish run, in spite of the ongoing sense of political uncertainty hanging over the UK government.

As the Conservatives have still not finalised a confidence and supply arrangement with the controversial Democratic Unionist Party (DUP) the strength of the minority government remains questionable.

This could limit the odds of the UK facing a hard Brexit, however, with Theresa May likely to be encouraged to take a more moderated approach to the negotiations.

So long as the talks with EU officials are seen to be progressing smoothly, with limited disagreement or souring of attitudes, the appeal of the Pound is expected to remain heightened.

Confidence in Sterling has also strengthened in response to signs of an increasing split within the Bank of England (BoE), as more policymakers appear to be shifting towards a hawkish outlook on monetary policy.

Although Governor Mark Carney has maintained a decidedly neutral view on interest rates, deterred by weak wage growth and slowing economic momentum, this was contrasted by the sudden hawkishness of chief economist Andy Haldane.

Given that Haldane is the most notorious dove on the Monetary Policy Committee (MPC) this change in attitude helped to bolster demand for the Pound, supporting GBP exchange rates ahead of the weekend.

However, this is unlikely to keep the GBP USD exchange rate on a stronger footing for long, as the odds of an imminent return to a tightening bias remain limited.

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As Virai Patel, Foreign Exchange Strategist at ING, noted:

‘The bottom line is that nothing has changed and even under the most hawkish of scenarios – that the post-Brexit 25bp rate cut is reversed later this year – a very shallow Bank Rate path means that a sustained period of GBP appreciation is unlikely. Our expectation for a slowdown in the UK economy should make the case for rate hike less compelling.’


GBP Forecast to Come Under Increased Pressure from Brexit Talks



The bullishness of the Pound is expected to fade in the coming days, particularly if the latest UK data fails to encourage investors.

Weaker data would alleviate the pressure on the BoE to consider raising interest rates, undermining the likelihood of tightening coming in the near future.

If the BBA mortgage approvals figure indicates a weakening in consumer confidence and the domestic housing market the GBP USD exchange rate could be quick to reverse its recent gains.

The underlying health of the UK economy remains questionable, leaving Sterling vulnerable to renewed downside pressure.

As Chris Hare, economist at HSBC, commented:

‘It is becoming increasingly clear that the UK housing market is slowing. Evidence from the RICS survey, alongside data on mortgage approvals and transactions, point to a weakening in demand. Annual house price inflation has softened to around 3%.’


US Dollar Weakens as Doubts Mount over Fed Rate Hike Timing



Confidence in the US Dollar, meanwhile, has fluctuated in response to less hawkish signals from members of the Federal Open Market Committee (FOMC).

Positive signs from the US housing market have not been enough to dispel concerns that inflation is not yet strong enough to support a Fed tightening cycle.

This is likely to leave the ‘Greenback’ under pressure ahead of next week’s personal consumption expenditure report, which is the Fed’s preferred measure of inflation.

If inflationary pressure is found to have eased in May, with forecasts pointing towards a dip from 0.2% to 0.0% on the month, the GBP USD exchange rate could benefit.

Alvin T. Tan, research analyst at Societe Generale, noted:

‘Given the dependence of US Dollar exchange rates on US bond yields and Fed policy expectations, periods of US disinflation will be damaging to the Dollar. In this regard, the return of disinflationary pressures in recent months does not bode well for the Dollar. Insofar as oil prices are affecting inflation expectations, falling oil prices are damaging to the Dollar.’


So long as inflation fails to pick up sharply the likelihood of another Fed rate hike before the end of the year could be further called into question.
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