No matter how strict the BoE stance towards rates was, the market did not believe the UK regulator. However, the market believes in the Fed’s intention to bring borrowing costs to neutral levels as soon as possible. How does this affect the GBPUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly pound fundamental forecast
History repeats itself. Forty years ago, Fed Chairman Paul Volcker recognized that a recession in the US economy was required to bring down excessively high inflation. As a result, the Fed began aggressively raising the federal funds rate. At the May meeting, the Bank of England officials said that consumer prices would rise above 10%, and UK GDP would be less than at the beginning of the year. Three members of the MPC voted in favor of a rate hike by 50 basis points, making the meeting a “Volcker moment” for the BoE.
The problem is that the reaction of currencies to events turned out to be completely different. In 1985, the GBPUSD hit an all-time low of 1.05, thanks to the USD strength. However, now the pound has not received the necessary support from the central bank. GBP is heading towards $1.2. It should be noted that the sterling fell below this level only three times. The first time was in the 1980s. The second time was during the Brexit referendum in 2016 and finally at the peak of the global economic recession in 2020. The last two events were associated with great uncertainty, which is difficult for markets to measure.
The current situation is more similar to the events of the 1980s. The markets believe the Fed, but not the Bank of England. It is generally accepted that any central bank can raise rates until something goes wrong. The BoE now admits that something must go wrong with the economy. As a result, the expectation that, after a series of hikes, the BoE will cut interest rates has already been priced in derivatives quotes. The contrast with the Fed, which could push borrowing costs up to 4%, is clear. This makes the yield differential between UK and US bonds negative and pushes the GBPUSD down.
Dynamics of spread between UK and US bond yields
The UK’s problems are not only proximity to Ukraine or the energy crisis. The country is reaping the fruits of breaking economic ties with the EU. Moreover, London and Brussels continue to clash over Northern Ireland, which could cause the suspension of the trade agreement with the further introduction of import duties. It seems that a trade war with no winners will soon begin and affect the sterling and the euro.
Brexit seriously aggravated the situation in the labor market. Wages are rising 4%, higher than pre-pandemic levels but below inflation. Employers actively use bonuses to attract employees, contributing to the CPI growth. At the same time, the worst cost-of-living crisis in half a century hit the country. The National Institute of Economic and Social Research predicts that the number of UK people living in poverty could reach 1 million over the next year.
GBPUSD trading plan for a week
Thus, the highest risks of stagflation and recession of the UK economy, the return of Brexit problems, and the aggressive tightening of the Fed’s monetary policy allowed the GBPUSD to reach the target of 1.226, as mentioned in the previous article. These factors also contribute to the pair’s decline even lower to the levels of 1.2 and 1.194. I recommend entering sales.
Price chart of GBPUSD in real time mode
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