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Pound Sterling rises in thin-trading week, BoE policy in focus

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FXStreet in Market News 12 388330
May 7, 2024 02:12

content provided with permission by FXStreet

  • The Pound Sterling trades close to 1.2570 against the US Dollar as investors shift focus to the BoE policy decision.
  • The BoE could provide meaningful cues on the timing of rate cuts amid easing price pressures.
  • Slower US job growth and a contraction in the Services PMI have raised concerns over the economic outlook.

The Pound Sterling (GBP) moves higher to 1.2570 against the US Dollar (USD) in Monday’s early American session but is still inside Friday’s trading range. The GBP/USD pair is expected to remain less volatile and will be guided by the market sentiment as the United Kingdom markets are closed on account of Early May.

The GBP/USD strengthens as the US Dollar weakens in the aftermath of United States Nonfarm Payrolls (NFP) and the ISM Services Purchasing Managers Index (PMI) data for April. The US Dollar Index (DXY), which tracks the US Dollar’s value against six major currencies, trades sideways above 105.00.

The overall data indicated that the US economy is losing strength: fewer jobs were added, the Unemployment Rate rose to 3.9%, wage growth slowed, and the ISM Services PMI fell below the 50.0 threshold – the level that separates expansion from contraction – to the lowest reading since December 2022.

Despite the downbeat overall picture presented by Friday’s data, investors didn’t bring forward  Federal Reserve (Fed) rate cut bets from September as the ISM Prices Paid subindex for the service sector rose significantly to 59.4 from 53.4 in March. High Prices Paid for service sector inputs renewed fears of inflation remaining higher, which is expected to allow the Fed to emphasize maintaining interest rates restrictive for a longer period. Respondents to the ISM survey said: “Inflation is raising our unit cost on products and services when compared to last year’s expenditures.”

Daily digest market movers: Pound Sterling advances as US Dollar drops

  • The Pound Sterling moves higher above 1.2550 ahead of Bank of England’s (BoE) interest rate decision, which will be announced on Thursday. The BoE is widely anticipated to hold interest rates steady at 5.25% for the sixth time in a row. Therefore, investors will keenly focus on the BoE’s guidance on interest rates.
  • The recent commentary from BoE Governor Andrew Bailey indicated that he is confident that headline inflation will return to the desired rate of 2% in April. This suggests that the central bank could deliver a slightly dovish commentary on the interest rate outlook and provide a concrete timeframe for starting to reduce interest rates. 
  • Reuters shows that financial markets anticipate the BoE reducing interest rates from the September meeting. Traders have also priced in one more rate cut by year-end. The speculation for only two rate cuts is significantly lower than the six anticipated at the start of the year. Andrew Baily also commented in the last press conference after the bank’s policy decision that market expectations for two or three rate cuts this year are not unreasonable.
  • However, a few BoE policymakers are still worried about stubborn wage growth feeding service inflation. UK Average Earnings excluding bonus are at 6.0%, almost double what the BoE views as required to be consistent for bringing inflation down sustainably to the desired rate of 2%.
  • Investors will also focus on how many BoE policymakers will join Swati Dhingra and vote to pivot to interest rate cuts. It is expected that BoE Deputy Governor Dave Ramsden could change its stance from neutral to dovish on interest rates. Investors’ confidence in Ramsden turning dovish escalated after he commented last month that risks of inflation remaining higher have receded. He also pointed out that inflation will not rebound again after returning to 2%, contrary to prior expectations that price pressure could revamp again.

Technical Analysis: Pound Sterling climbs above 1.2550

The Pound Sterling trades inside Friday’s trading range during Monday’s European session. The GBP/USD pair formed a Shooting Star candlestick pattern on a daily timeframe on Friday as it reversed its initial gains after the US Services PMI Prices Paid rose significantly. The above-mentioned candlestick is a bearish reversal pattern and its formation near the crucial resistance of 1.2500-1.2600 adds to its strength. 

A breakdown of the Shooting Star pattern would trigger if the pair breaks below Friday’s low of 1.2522. The near-term outlook of the Cable is still positive as it is trading above the 20-day Exponential Moving Average (EMA), which trades around 1.2520.

The 14-period Relative Strength Index (RSI) oscillates in the 40.00-60.00 range, suggesting indecisiveness among market participants.

US Dollar FAQs

The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.

The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.

In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.

Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.