In the European session on Monday, Pound Sterling (GBP) experiences significant downward pressure, primarily attributed to diminishing expectations of an early rate cut by the Federal Reserve (Fed). Resilient United States Nonfarm Payrolls (NFP) data from Friday have contributed to this sentiment, reducing the likelihood of a Fed rate cut in March. The robust US job creation figures, coupled with unexpected wage growth, indicate persistent inflation pressures.
The Bank of England (BoE) is confronted with a challenging scenario as fears of a technical recession in the UK economy intensify. Revised Q3 Gross Domestic Product (GDP) estimates from the UK Office for National Statistics (ONS) reveal a contraction of 0.1%, amplifying concerns about the economic outlook. Higher interest rates have exacerbated the cost-of-living crisis in the UK, prompting businesses to operate with reduced capacity.
The Pound Sterling falls to a near seven-week low around 1.2600, reflecting weakened appeal for risk-perceived assets. The positive US employment data has prompted traders to scale back rate-cut expectations by the Federal Reserve, impacting the outlook for risk-sensitive assets. January’s strong labor market data underscores robust demand for workers and higher wage growth, influencing businesses with a strong order book.
The CME Group Fedwatch tool indicates an unlikely rate cut in March, with a little over 57% chance for a rate cut by 25 basis points to 5.00%-5.25% in May. Despite the Bank of England adopting a seemingly more hawkish stance on interest rates than the Fed, the Pound Sterling faces significant pressure. Investors speculate that a subdued economic performance and rising geopolitical tensions may prompt BoE policymakers to cut interest rates sooner than anticipated.
The UK economy teeters on the brink of a technical recession, having contracted by 0.1% in the third quarter of 2023. The potential absence of economic recovery in the UK could significantly impact the labor market. BoE policymaker Swati Dhingra voted for a rate cut of 25 bps in the recent monetary policy meeting, while policymakers Catherine Mann and Jonathan Haskel supported a rate hike.
The vulnerable economic prospects in the UK may compel BoE policymakers to lean towards easing interest rates in upcoming meetings. Investors will closely monitor the final S&P Global Composite and Services PMI for January for further insights into the economic landscape, with expectations that both indices will remain steady from their preliminary readings.
Technical Analysis: Pound Sterling dips to near seven-week low around 1.2600
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Pound Sterling falls further to near the crucial support of 1.2600 as the market sentiment is bearish. The short-term outlook of the GBP/USD is to the downside as the pair has dropped below the 20-day and 50-day Exponential Moving Averages (EMAs), which are around 1.2687 and 1.2642, respectively.
The Cable hovers near the horizontal support of the Descending Triangle chart pattern, which is plotted from December 21’s low point at 1.2612, while the downward-sloping trendline is placed from December 28’s high point at 1.2827.
The 14-period Relative Strength Index (RSI) declines towards 40.00, a level that could provide support to the current downside momentum.
POUND STERLING FAQS
What is the Pound Sterling?
The Pound Sterling (GBP) is the oldest currency in the world (886 AD) and the official currency of the United Kingdom. It is the fourth most traded unit for foreign exchange (FX) in the world, accounting for 12% of all transactions, averaging $630 billion a day, according to 2022 data.
Its key trading pairs are GBP/USD, aka ‘Cable’, which accounts for 11% of FX, GBP/JPY, or the ‘Dragon’ as it is known by traders (3%), and EUR/GBP (2%). The Pound Sterling is issued by the Bank of England (BoE).
How do the decisions of the Bank of England impact on the Pound Sterling?
The single most important factor influencing the value of the Pound Sterling is monetary policy decided by the Bank of England. The BoE bases its decisions on whether it has achieved its primary goal of “price stability” – a steady inflation rate of around 2%. Its primary tool for achieving this is the adjustment of interest rates.
When inflation is too high, the BoE will try to rein it in by raising interest rates, making it more expensive for people and businesses to access credit. This is generally positive for GBP, as higher interest rates make the UK a more attractive place for global investors to park their money.
When inflation falls too low it is a sign economic growth is slowing. In this scenario, the BoE will consider lowering interest rates to cheapen credit so businesses will borrow more to invest in growth-generating projects.
How does economic data influence the value of the Pound?
Data releases gauge the health of the economy and can impact the value of the Pound Sterling. Indicators such as GDP, Manufacturing and Services PMIs, and employment can all influence the direction of the GBP.
A strong economy is good for Sterling. Not only does it attract more foreign investment but it may encourage the BoE to put up interest rates, which will directly strengthen GBP. Otherwise, if economic data is weak, the Pound Sterling is likely to fall.
How does the Trade Balance impact the Pound?
Another significant data release for the Pound Sterling is the Trade Balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports over a given period.
If a country produces highly sought-after exports, its currency will benefit purely from the extra demand created from foreign buyers seeking to purchase these goods. Therefore, a positive net Trade Balance strengthens a currency and vice versa for a negative balance.
