Jump to content

Could pound sterling now strengthen against the US dollar?



The Bank of England is forecasting a base interest rate rise in the ‘coming months.' But the US Federal Reserve is insisting that rising inflation is 'transitory.' Could a policy divergence see sterling soar?

Source: Bloomberg

GBP/USD is one of the most popular Forex currency pairs. And right now, 73% of IG clients are long on the market, with £1 currently buying $1.34.

This optimism for sterling is due to the perceived likelihood that the UK’s Bank of England will raise its base interest rate before the US’s Federal Reserve. As a currency’s base rate is arguably the most important factor in determining its strength, the client consensus isn’t particularly surprising. Moreover, many of these clients will be position traders, prepared to wait until the UK raises its base rate. But the Federal Reserve might act first.

Do you think sterling will strengthen against the US dollar?

Trade 100+ FX pairs with the UK's No. 1 forex provider. * Enjoy fast execution and low spreads. We'll never fill your order at a worse price. Create an account with IG to start trading forex today.

* By number of primary relationships with FX traders (Investment Trends UK Leveraged Trading Report released June 2020).

Where next for sterling?

The strength of sterling is directly tied to potential interest rate rises in the face of racing inflation. On 4 November, the Bank of England held off from raising the base rate from its historic low of 0.1%, which saw sterling fall 1% against the dollar. Governor Andrew Bailey was labelled a 'bad boyfriend' for indicating to traders that a rise should be expected.

While the Monetary Policy Committee (MPC) voted 7-2 in favour of no change, Bailey described it as a ‘close call,’ with the MPC saying there was ‘value’ in waiting to see how the jobs market coped with the end of the furlough scheme. And it signalled it will be raising rates in the ‘coming months.’

But with the Resolution Foundation reporting that only 136,000 out of the 1.1 million people still on furlough had moved into unemployment or inactivity, the chance of a rate rise has probably now fallen.

And Bailey said the decision was ‘a reflection of the position we’re in.’ His view is that inflation is being caused by the global supply chain crisis, and therefore increasing interest rates domestically will make little difference to consumer prices. But he accepts there will be ‘some need to increase interest rates to bring inflation sustainably back to target.’ And the ONS has predicted that inflation will rise to 5% by April 2022, more than double the Bank’s 2% target.

However, raising rates too soon risks strangling the green shoots of economic recovery, as it would increase the cost of servicing debt, including mortgages and credit cards.

And National Insurance is increasing by 1.25 percentage points in 2022. Corporation tax is rising from 19% to 25% in 2023. Income tax bands are frozen until 2026, while council tax continues to rise by 5% a year. There are even rumours that the student loan repayment threshold might soon be lowered. Demand, and therefore inflation, could drop off without a rate rise.

With rising energy, food, and petrol prices contributing to the cost-of-living crisis, the Bank has a very delicate balance to strike. The most recent MPC report expects price rises to outstrip earnings until 2024. Accordingly, rates could still rise to 1% by the end of 2022.

Federal Reserve
Source: Bloomberg

US inflation surges

Pressure on the Federal Reserve is also intensifying as US inflation is now running at 6.2%. This is 1.2 percentage points higher than the UK’s expected peak and represents the highest inflation rate since 1990.

Worryingly, the labour department report shows prices rose 0.9% in October, more than double the 0.4% jump in September. Moreover, energy prices are up 30% and food up 5.3% over the past year.

Like the UK, these pressures are being blamed on global supply chain issues. But last week, Chairman Jerome Powell said that inflation has been ‘longer lasting than anticipated,’ and that it was ‘very difficult to predict the persistence of supply constraints.’

President Jo Biden has also just passed a $1.2 trillion infrastructure bill, and could soon increase social spending by $1.75 trillion. This cash influx is likely to have an additional inflationary effect.

This leaves the currency pair in an interesting position where it seems likely that the UK will raise rates before the US, despite having significantly lower inflation. If it does, then sterling will rise. But with inflation running so high across the pond, the Federal Reserve could emulate the Bank of England's unpredictability, and spring a surprise on unsuspecting traders.

Charles Archer | Financial Writer, London
16 November 2021


Recommended Comments

There are no comments to display.

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
  • Blog Statistics

    • Total Blogs
    • Total Entries
  • Latest Forum Topics

  • Our picks

    • Swiss Franc Firming Against US Dollar and Euro. Will Momentum Take CHF Higher?
      EUR/CHF made a 7.5-year low at the end of last month at 0.9699, moving below the previous low of 0.9804.

      Since breaking lower, the price has not managed to reclaim 0.9804 and it may continue to offer resistance. The 21-day Simple Moving Averages (SMA)is currently at that level, potentially adding resistance.

      Further up, the recent peak of 0.9957 might offer resistance ahead of the break point at 0.9973.

      In the last session, the price has crossed below the 10-day SMA and remains below the 21-, 55-, 100- and 200-day SMAs.

      A bearish triple moving average (TMA) formation requires the price to be below the short term SMA, the latter to be below the medium term SMA and the medium term SMA to be below the long term SMA. All SMAs also need to have a negative gradient.

      Looking at EUR/CHF, the criteria for a bearish TMA has been met and may indicate that bearish momentum could evolve further.

      Support might be at the recent low of 0.9699 or further down at the 161.8% Fibonacci Extension of 0.9638.


      Chart created in TradingView 


      USD/CHF has bounced off low made at the start of this month at 0.9470 to trade in a wide range of 0.9545 – 0.9650. These levels might provide support and resistance respectively.

      While the price is below all short-, medium- and long-term Simple Moving Averages (SMA), they have positive and negative gradients. This may suggest a lack of conviction for directional momentum that might see further range trading.

      Re-iterating this possibility is the price criss-crossing the 10-day SMA. Recent history has shown that when the price crosses the 10-day SMA, momentum in that direction continues. That is not the case over the last week.

      The recent low of 0.9470 may provide support ahead of the break point at 0.9460. On the topside, resistance might be at the break point of 0.9710 or the July peak of 0.9886.

       Chart created in TradingView

      Daniel McCarthy, Strategist Daily FX

      Source: Daily FX
      • 0 replies
    • Post in FTSE 📈 to drop soon
      Check out phillo's analysis on the FTSE100. Are you tracking any technical analysis for the FTSE you want to share? If so join the forum.
        • Like
    • Rolls-Royce share price: half-year results
      Rolls-Royce shares (LON: RR) sunk by 10% to 83p on Friday after half-year results spooked investors over long-running problems with supply chain issues and inflation.
      • 0 replies
  • Create New...