High and strong March inflation data points to another 25bp rate hike from the Bank of England on Thursday, which means our bullish outlook for GBP/USD is unlikely to change much. The currency pair's gains this week reached the resistance level 1.2680, before settling around 1.2625 at the time of writing.
- We think the BoE is unlikely to deliver a dovish surprise, given that CPI has been in double digits for far too long.
- Today, the Bank of England is likely to maintain its data-driven guidance.
- It will probably decide not to explicitly announce a pause and will leave the door wide open for further price hikes.
- In line with market expectations, I would also expect a 25bps rally to 4.5% with the MPC vote likely to split 7-2.
After it slowed the pace of tightening to a record 25 basis points at its previous meeting in March, the market was initially quick to cut further interest rate increases. But the inflation data had other ideas as the UK CPI remained stubbornly high and above the 10% threshold.
Continued double-digit inflation has raised the potential for another rally, which explains why GBP/USD managed to reach repeated yearly highs recently. Meanwhile, the bank could revise its GDP forecast upwards, thanks to a stronger-than-expected job market and the government's additional energy support in the second quarter. If the BoE reaffirms that further tightening could be on the outlook due to continued inflation, that could send GBP/USD above 1.26 and on its way to the 1.30 psychological resistance.
This means that the downside risk for our GBP/USD bullish outlook is mostly due to the dollar. With the US job market remaining very strong and the Federal Reserve fighting interest rate cut expectations, the greenback showed some signs of life against certain currencies. Although there are some signs that inflation has peaked in the UK, the rate hasn't fallen below the 10% level for 7 months in a row now, or 9 months if you round the August 2022 reading at 9.9%. The inflation was very hot.
The BoE will want to see clear evidence that it is heading towards its 2% target in the not too distant future before it gets comfortable. Therefore, it is likely to keep all of its options open today, Thursday, in case inflation continues to rise - even if that potential 25 basis point increase would be the last of the cycle. Inflation missed the Bank of England, with CPI remaining nearly 2 percentage points higher than the February forecast. For this reason alone, one should expect the Bank of England to remain on a more hawkish tone than it would otherwise have been at this point in the tightening cycle. The BoE rate hike is fully priced in, so there is a risk that we may see an initial negative reaction as the people who ran the BoE up front take profits on GBP/USD longs. But given that inflation is so high in Britain, I don't think the BoE will be very resistant to raising interest rates in the future. This means that the GBP/USD may avoid falling too drastically, if at all.
Thus, the overall trajectory of the currency pair is likely to remain bullish. In fact, if the BoE is more hawkish than expected, we may see the start of a rally towards 1.30 after that. GBP/USD might head that way anyway, as it's not all about the Bank of England's interest rate decision. The other side of the equation when it comes to the GBP/USD exchange rate is, of course, the US dollar, which is starting to show some signs of life again after its recent declines.
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