Pound Sterling to Dollar Outlook: "Bullish Scenario to Remain Intact as long as it Holds 1.26" say Scotiabank

December 21, 2023 - Written by John Cameron

STORY LINK Pound Sterling to Dollar Outlook: "Bullish Scenario to Remain Intact as long as it Holds 1.26" say Scotiabank

GBP/USD Exchange Rate Slides to 1.2650 After UK Inflation Data, US and UK Rate-Cut Expectations Dominate Markets

The Pound spiked lower following the UK inflation data with the Pound to Dollar (GBP/USD) exchange rate dipping to lows at 1.2650 from above 1.2700 before settling just above 1.2650

The dollar overall remained on the defensive amid expectations of Federal Reserve rate cuts in 2024 while favourable risk conditions also helped limit Pound losses in global markets.

Scotiabank considers the GBP/USD bullish scenario will remain intact as long as it holds 1.2600/20.

The headline UK annual inflation rate retreated further to 3.9% for November from 4.6% previously. This was significantly below consensus forecasts of 4.4% and the lowest reading since September 2021.

Petrol prices fell significantly on the month with overall fuel prices declining 10.6% over the year.

The core inflation rate also declined sharply to 5.1% from 5.7% and below expectations of 5.5%. This was the lowest reading since February 2022.

The services-sector inflation rate declined to 6.3% from 6.6%.

ONS chief economist Grant Fitzner commented; “The biggest driver for this month’s fall was a decrease in fuel prices after an increase at the same time last year. Food prices also pulled down inflation, as they rose much more slowly than this time last year.”

Following the data, markets moved to price in a further interest rate cut of 25 basis points next year with rates below 4.00% by the end of 2024.

A rate cut in May is fully priced in and markets consider that a March move is now a live issue.

The UK 2-year gilt yield declined 17 basis points to 4.12%.

Simon French, chief economist at Panmure Gordon commented; “Those arguing over summer that the UK was on a sustained & higher inflation path to the rest of the developed world starting to look a bit daft.”

Pantheon Macroeconomics economist Samuel Tombs expects further good news and added; “the surprisingly sharp fall in CPI inflation reinforces the likelihood that the MPC will begin to reduce Bank rate in the first half of 2024, far earlier than it has been prepared to signal so far.

Ipek Ozkardeskaya, senior analyst at Swissquote Bank, expects the BoE will still be cautious; “Yet in absolute terms, core inflation in Britain is still more than twice the Bank of England’s 2% inflation target. And even though the pace of easing is more than welcome, the Bank of England is still last in line to join the pivot party.”

He added; “Therefore, hawkish BoE expectations should limit the pound selloff if, of course, investors continue to divest from the US dollar on the back of softening Fed expectations.”

Domestically, the inflation data will underpin asset prices with gains for UK equities.

Global conditions will also be important for the Pound and risk appetite is also benign with global equities making further headway.

US economic developments will also be a key element.

Fed officials have continued to push back against expectations of aggressive rate cuts, but markets are still pricing in an 80% chance of a March rate cut.

For example, Atlanta Fed President Bostic commented on Tuesday; “Inflation is going to come down relatively slowly in the next six months, which means that there's not going to be urgency for us to start to pull off of our restrictive stance.”

US data will remain important for market sentiment with the dollar in a better position to fight back if there is strong data.

According to MUFG; “The US PCE inflation data on Friday remains the key piece of data and really the final key data of the year and an upside surprise is required in order to give the Fed’s push-back attempts a bit more credibility.”

It added; “If an upside surprise does not materialise, it will be difficult for the Fed to thwart expectations of a March rate cut which will reinforce the dollar selling momentum, possibly through the quiet holiday period and into the start of 2024.”

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TAGS: Pound Dollar Forecasts