GBP/USD outlook: BoE’s hawkish pause not a game changer

• GBP/USD outlook: Cable finds mild support from hawkish BoE
• US NFP in focus next after Fed’s hawkish pause
• UK GDP among next week’s key data highlights

Ahead of the Bank of England’s rate decision, the GBP/USD was holding steady near 1.22 handle, benefitting slightly from the dollar’s weaker response to what was a hawkish hold from the Federal Reserve rate decision. Not many people were expecting a rate hike from the BoE either, with the market attaching a 93% probability of a second consecutive hold after 15 back-to-back interest rate hikes. The rationale being that the BoE is confident that the past rate hikes are doing their job and will take some time to see the full effect on inflation and the economy. In fact, inflation data has been showing signs of cooling and we have seen continued weakness in growth data while the labour market has also weakened. What’s more, the UK central bank was highly unlikely to deviate from the Fed and the ECB by hiking rates again.

BoE holds rates unchanged at 5.25%

Lo and behold, the BoE didn’t disappoint market expectations and decided to hold rates steady at 5.25%. But yet again, this decision wasn’t unanimous. Far from it, in fact. The BoE voted 6-3 to keep rates unchanged, suggesting some member wanted to hike again. The split shows it is far too early to think about rate cuts and explains why we saw an initial positive reaction in the pound.

Indeed, the decision was “finely balanced” between no change and hike, according to the BoE. Meanwhile BoE Governor Bailey said the MPC would be watching “closely” to see if further rate increases were needed and that it is “much too early to be thinking about rate cuts.” Greene, Haskel and Mann voted to raise by 25bps.

Inflation to remain above target for longer: BoE

FX traders were also interested in the central bank’s forecasts, although whether one should trust them is a topic for another day.  

Inflation is still high at 6.7% compared to other G7 countries, but it has finally started to come down in recent months after being in double digits for several months until April. Clearly more progress is needed on this front, before the BoE even discusses rate cuts. The central bank’s latest forecasts show that inflation is likely to be 4.6% by Q4 this year, lower than the central bank had expected back in August (4.93%). However, the BoE thinks inflation in one year’s time is going to be around 3.1% compared to 2.82% it had predicted previously, and now envisages a drop below the 2% target in Q4 of 2025 rather than Q2.

In terms of growth, well the BoE still thinks the economy will expand by half a percent this year but now envisages no growth for next year.

Here are the BoE’s updated economic projections:

Inflation:

• 2023 4.75% (prev. 5.00%)
• 2024 3.25% (prev. 2.5%)
• 2025 2% (prev. 1.50%)

Growth:

• 2023 0.50% (prev. 0.50%)
• 2024 0% (prev. 0.50%)
• 2025 0.25% (prev. 0.25%)

In a nutshell

So, the BoE thinks inflation is going to be stickier than previously thought, which may mean high rates for longer. But recent PMI data has shown that growth is anaemic, if not negative. In October, business activity contracted for a third straight month, raising concerns that the UK could be heading for a recession. The market believes that the next move from the Bank of England will be a rate cut, although this is not expected until the second half of next year.

The pound’s initial reaction was a positive one as it jumped about 20 pips on the news. The markets interpreted the rate decision and BoE’s language as  modestly hawkish. Perhaps some investors were looking for a more dovish vote split. What’s more, with inflation now not seen falling below 2% the final months of 2025, we will probably have to wait longer for rate cuts than expected.

Fed’s hawkish hold fails to push dollar higher – for now

Interestingly, the dollar’s response to the hawkish hold from the Federal Reserve was bearish. Investors seem to agree that the Fed's decision to leave rates unchanged for a second meeting in a row means it is

coming to the end of its historic tightening campaign, arguing that interest rates will only go lower from here. We have seen a sizeable drop in US bond yields, and this has boosted the appeal of other high-beta currencies like the Aussie and kiwi, while also supporting the stock markets. The dollar bears are now anticipating some weakness in US data to help knock the dollar off its perch. Wednesday’s weaker-than-expected release of ISM manufacturing PMI data caused a sharp intra-day weakness in US dollar. Yet, the stronger data releases hardly caused any positive reaction. It appears as though the market has now priced in all the good news for the dollar. But this thesis will be tested time and again with the upcoming data release. So far, the trend of US data hasn’t turned lower to justify calls for a top in US dollar.

GBP/USD outlook: What’s next for the cable?

The economic calendar remains busy for the GBP/USD, with the release of top tier US data on Friday. From the UK, there isn’t an awful lot to look forward to until next Friday’s GDP and other key data releases.

US NFP and ISM services PMI among key US data highlights on Friday

The “higher for longer” narrative will be put to the test again on Friday with the release of the October US jobs report and the ISM services PMI data. As mentioned, with the dollar moving sharply higher in the last three months or so, most of the positivity may be priced in. For the dollar to accelerate from here, it will take a lot more effort. Put another way, if upcoming US data were to disappoint, the US dollar’s downside reaction may well be more pronounced than would otherwise be the case. So the dollar bulls will need to see a strong set of numbers on Friday, otherwise the dollar’s bullish trend may well reverse.

UK GP and US consumer sentiment among next week’s highlights

The week ahead is void of any major data releases until Friday, when we have important data from both sides of the pond, which should impact the GBP/USD outlook.

UK growth figures for September and Q3 will be released alongside construction output, industrial production and a few other macro pointers. Together, these data releases will help shape up investor expectations about the path of UK interest rates moving forward. It is highly likely that the BoE is done with interest rate increases, but how long will rates remain high is the key question. Should these macro highlights point to surprising strength in the UK economy, then this should support the pound.

Following this week’s data dump, the week ahead was always going to be quieter for US data. The resilience of the US economy and the potential for inflation to remain high for longer is what drove the dollar to new highs for 2023. But we did see some signs of weakness in data this week and if that turns into a trend then we could possibly see a dollar reversal soon. Next week’s US data highlight is on Friday with the release of UoM Consumer Sentiment data.

GBP/USD technical analysis

Source: TradingView.com

The GBP/USD’s consolidation continues. While this week’s price action has so far been bullish, more evidence is required to suggest rates have bottomed. A break above the bearish trend line is a prerequisite for any bottoming talks. We will also need to see a break above the key resistance zone in the 1.23 area at some point in the next few days so that the cable forms a higher high. Until that happens, it is important not to jump into any conclusions, especially with key US jobs data coming up on Friday. Key short-term support now comes in at 1.2170, the base of today’s breakout. The bulls will want to keep the GBP/USD above this level if they want to prevent another drop towards 1.20.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R