British Pound Outlook: GBP/USD Up as Traders Look Past UK Political Turmoil. Now What?

[ArvinIG]

BRITISH POUND KEY POINTS:

• GBP/USD rises after UK Prime Minister Boris Johnson announces his resignation
• Although political uncertainty may cause volatility from time to time, it is unlikely to become the main driver of sterling in the short term
• The Bank of England's monetary policy and the UK macroeconomic outlook should be more relevant for the pound during the second half of the year

Most Read: US Dollar Price Action Setups: EUR/USD, GBP/USD, USD/CAD, USD/JPY

The British Pound traded moderately higher against the U.S. dollar on Thursday, up about 0.65% to 1.2000, despite heightened political uncertainty in the UK after Boris Johnson announced his resignation as Prime Minister following several scandals that plagued his administration over the past few months. Traders and investors had already anticipated this move after dozens of senior ministers stepped down in recent days in protest over Johnson's leadership and his handling of allegations of misconduct against a prominent ally, so the formal announcement did not spark FX turbulence.

While the process of selecting the next head of government may trigger volatility from time to time, it will not be the main driver of sterling. It is true that a new prime minister could open the door to some fiscal stimulus in the form of tax cuts later in the year and pave the way for a more aggressive central bank, but this will be a theme for the fall.The new resident of 10 Downing Street could also adopt a less confrontational stance toward the European Union, creating a more favorable environment for sterling; but again, there are too many unknowns at this point to draw any major conclusions.

Looking ahead, growing headwinds on the macro front for the UK and monetary policy divergence between the Fed and BoE will continue to be the main price action catalysts in the foreign exchange market. To provide context, UK activity is decelerating rapidly, raising the probability of a recession in 2023. Recognizing these risks, policymakers have kept a “steady-handed approach”, raising borrowing costs in small increments to avoid adding unneeded stress to an economy at the brink of a cliff.

With annual CPI on its way to exceed 11% in the fall, BoE may temporarily abandon its cautious stance and raise interest rates by half a percentage point to 1.75% at its August meeting, but this will likely be a one-off measure before returning to the standard 25 bps hike. The Federal Reserve, for its part, has retained a hawkish bias, signaling a rapid tightening path to restore price stability. While Wall Street doubts that the Fed will stick to its plans to remove accommodation forcefully, the institution has shown no willingness to pivot; in fact, the June FOMC minutes revealed that a more restrictive stance may be appropriate if elevated inflationary pressures were to persist.

In the current environment, the U.S. dollar should remain supported against the pound. This means that the path of least resistance for GBP/USD is lower, at least from a fundamental standpoint. The outlook could change, especially if the Fed blinks, but we don't yet have strong evidence to suggest that will happen soon.

GBP/USD TECHNICAL ANALYSIS

After hitting a multiyear low near 1.1875 yesterday, GBP/USD has staged a moderate rebound, guided higher by a short-term rising trendline, as shown in the 30-minutes chart below. If cable continues its trek upwards, initial resistance appears at 1.2022, the 50% Fibonacci retracement of the July high/July low move. On further strength, the focus shifts to 1.2056, followed by 1.2085/1.2090 and then 1.2125. On the flip side, if sellers return and push prices lower, trendline support comes around 1.1960. If this floor were to be breached, GBP/USD could be on its way to retest its 2022 lows.

GBP/USD TECHNICAL CHART

GBP/USD Chart Prepared Using TradingView

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Diego Colman, Market Strategist for DailyFX
08 July 2022