GBP USD Exchange Rate Under Pressure as Markets Brace for Federal Reserve Rate Hike

June 13, 2018 - Written by Frank Davies

STORY LINK GBP USD Exchange Rate Under Pressure as Markets Brace for Federal Reserve Rate Hike

The Pound US Dollar (GBP/USD) exchange rate remained under pressure on Wednesday as investors reacted with disappointment to the latest UK consumer price index data.

As the headline CPI held steady at 2.4% on the year in May, remaining at a one-year low, this prompted speculation that the inflation rate has peaked.

This weaker showing could undermine the liklihood of the Bank of England (BoE) raising interest rates at its August policy meeting, a prospect which weighed heavily on demand for the Pound.

Although confidence in the US Dollar was somewhat limited as markets braced for the Federal Open Market Committee (FOMC) decision later tonight this was not enough to prevent the GBP/USD exchange rate sliding lower.

Stronger UK Retail Sales to Shore up Pound US Dollar Exchange Rate

As both the latest UK wage growth and inflation data disappointed expectations this has left the Pound on a generally weaker footing.

There are concerns among investors that this softer data could be enough to prompt the BoE to take a more cautious policy outlook, in spite of recent signs of hawkishness.

Even so, James Smith, Developed Markets Economist at ING, noted:

‘Were it not for energy costs though, we suspect inflation would be falling further. Prices have mostly adjusted to the pound’s post-Brexit plunge, and we expect core CPI to fall back to the 2% target next month, and we think it will stay there or just below for at least the next few months.

‘On the face of it, the fact that core inflation is now back at target takes some pressure off the Bank of England to raise rates further – though when it comes to judging underlying inflationary pressures, it’s wage growth that policymakers have their eye on.

‘We still think an August rate rise is more likely than not, but this does rely on the economy showing more convincing signs of recovery after the weak first quarter.’

A stronger showing from Thursday’s UK retail sales data may offer GBP exchange rates a rallying point, however.

If consumer spending is found to have picked up in May this is likely to encourage greater confidence in the domestic outlook, given the significant role of consumers in driving economic growth.

Another downside surprise, on the other hand, could leave the GBP/USD exchange rate in a slump.

GBP USD Exchange Rate Forecast to See Limited Losses on Federal Reserve Rate Hike

Tonight’s Federal Reserve policy announcement is not expected to provoke much volatility for the US Dollar, meanwhile.

Investors are confident that Fed policymakers will opt to raise interest rates once again, with the impact of a rate hike already effectively priced into USD exchange rates.

As analysts at Nomura commented:

‘We think it is highly likely that the FOMC will raise rates at the 12-13 June meeting. At this point, it would be extremely surprising were the Committee to forego a rate hike. Consistent with the May FOMC minutes, we believe the Committee will raise the target range for the federal funds rate by 25bp, to 1.75-2.00%, but will increase the interest rate on excess reserves (IOER) by only 20bp, 5bp lower than the top of the target range. Economic data have indicated accelerating activity over the intermeeting period, with an unemployment rate at 3.8% and inflation approaching the Committee’s 2% objective. Given that economic momentum has accelerated since March, we expect the Committee’s new rates forecast to reflect a total of four rate hikes in 2018, up from three previously. While a rate hike appears likely, we expect the mechanics of the policy change to be somewhat different in June.’

If the Fed’s policy outlook proves more hawkish in nature then the US Dollar could push sharply higher across the board.

Any signs of hesitance, though, could offer support to the GBP/USD exchange rate overnight.

Further volatility is likely on the back of Thursday’s advance retail sales data, which is forecast to show a modest improvement on the month.

The US Dollar also remains vulnerable to political developments, with investors still wary of the prospect of a trade war erupting between the US and its allies.

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TAGS: Pound Dollar Forecasts