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Pound Sterling Sentiment Split on Tax and Rate Cut Expectations, Holds 1.26 vs Dollar

February 22, 2024 - Written by David Woodsmith


The Pound to Dollar exchange rate (GBP/USD) was unable to hold 1.2650, but has held above 1.2600 and settled around 1.2620 on Wednesday.

Fiscal and monetary policy expectations will continue to have an important impact on the Pound with evidence of divergence tending to limit Pound buying.

According to ING; “A softer dollar environment could see GBP/USD edge up to 1.2670/80 today, but we would not chase the move higher.”

Hopes for tax and interest rate cuts should provide net Pound support on growth grounds with Thursday’s PMI business confidence data important for Pound sentiment.

There are expectations of fiscal support in the March budget, but the Pound has been hampered by slightly more dovish rhetoric from Bank of England Governor Bailey in testimony to the Treasury Select Committee who reiterated that interest rates could be cut before inflation hit 2%.

As far as fiscal policy is concerned, the UK recorded a £17.6bn budget surplus for January 2024 compared with £7.5bn the previous year. Spending declined significantly due to lower debt interest payments and a reduction in energy subsidies.

The deficit for the first 10 months of 2023/24 declined to £96.6 billion from £99.7bn the previous year and sparked fresh speculation over tax cuts.

Lindsay James, investment strategist at Quilter Investors noted an important political consideration; “With recent by-election results suggesting that the Labour party continues to have the advantage as we head towards the general election, Hunt will be under pressure to offer tax cuts.”

He added; “However, with his hands largely tied by the state of the nation’s finances, investors must be realistic about the prospects for the extent of this, or prepare for more savage cuts to the U.K.’s already under-strain public services.”

Martin Mikloš, research economist at the Institute for Fiscal Studies maintained a cautious stance and pointed to the importance of growth and inflation forecasts.

He added; “With public services under strain, pressures to offset some of the record-breaking tax rise seen since 2019, and the need for a credible plan to get debt on a falling path the Chancellor’s forthcoming Budget will not be an easy one to navigate.”

The dollar has edged lower, although overall ranges have remained very narrow.

ING pointed to two potential elements curbing potential dollar support. It considers the latest Canadian inflation data may have wider implications.

The Canadian inflation data released on Tuesday was notably weaker than expected as the year-on-year inflation rate declined to 2.9% from 3.4% and well below forecasts of 3.3%.

There were also significant declines in the core inflation readings for the month.

ING noted; “Investors may increasingly be thinking that January's US CPI number was an aberration and that when the February CPI figure is released on 12 March, the disinflation narrative will be restored.”

ING also pointed to the gains in Chinese equities with the benchmark CSI300 index 10% off its recent lows.

It questioned the rally’s durability, but added; “USD/CNH has now moved under 7.20 and is dragging USD/Asia lower along with it. As we know, these trends typically provide a soft undercurrent to the dollar.”

MUFG added; “The paring back of China-related investor pessimism is putting a dampener on the US dollar’s upward momentum.”

The latest set of Federal Reserve minutes will be released on Wednesday with a detailed record of the January 31st meeting.

According to MUFG; “We expect the minutes to show that FOMC participants are mostly united in the view that they can take their time before cutting rates.”

MUFG added; “In light of recent stronger US economic data releases, the US rate market has pushed back the expected timing of the first Fed rate cut to June. We are not expecting the minutes from the January FOMC meeting to significantly alter those expectations today although an earlier rate cut in May is unlikely to be ruled out.”
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