GBP/USD Weekly Forecast: Will the Bank of England step out?

The rapidly improving coronavirus situation in the UK, a strengthening economy and rising inflation helped propel the sterling to its best close against the US dollar in a month. The GBP/USD rose 1.2% on the week, is up 2.1% since its low of 1.3628 eight sessions ago and reversed on Friday just shy of the 61.8% Fibonacci retracement of the May 31 to July 20 4.1% decline.

Expectations for a positive economic assessment out of the Bank of England (BOE) and perhaps hints at the timing and conditions for a reduction in the Asset Purchase Facility were an undercurrent for the weeks gains.

Until the BOE meeting on Thursday the comparison to the dovish rate pronouncements from the Federal Reserve will continue to aid the sterling.

The Federal Open Market Committee (FOMC) statement issued with the status quo Wednesday rate decision noted that “progress” had been made toward the bank's goals but provided no guidance on the timing of a much anticipated reduction in the bond purchase program.

Chair Jerome Powell was equally recitient, leaving markets largely without policy directive until the next Fed meeting on September 21-22.

In his press conference, Mr. Powell said that the withdrawal of monetary support has become an active topic among the governors. He noted the US job market still had “some ground to cover” before the bank would begin the reduction of its $120-billion-a-month in purchases of Treasury and mortgage-backed securities.

Treasury yields in the US were slightly lower on the week, reflecting the lack of a counter view in the credit market to moderating US growth and the still active pandemic-induced labor market and supply chain problems..

British economic information was limited with Housing Prices in July not quite as buoyant as expected, but that comes after the very strong gains of the past year.

Inflation remains a key ingredient for the BOE. The Consumer Price Index (CPI, y/y) has jumped from 0.7% in January to 2.5% in June. Unlike the Federal Reserve with its adoption of inflation-averaging, the BOE has not tried to insulate rate policy from its responsibility for inflation control.

In the US, Durable Goods Orders in June were weaker than forecast though the impact was mitigated by substantial positive revision in May. Second quarter GDP came in at 6.5%, well below the 8.5% forecast. The Core PCE reading for June was slightly lower than predicted, but as the Fed has disavowed any policy impact it made no print on the market.

GBP/USD outlook

Bias in the GBP/USD is higher with an emphasis on the stronger economic situation in the UK. The rapid recent improvement in the sterling leaves some room for profit-taking, especially if the BOE is more cautious than expected

The contrast between the Fed and the BOE approach to inflation is a fundamental benefit for sterling. Even if the BOE governors do not begin the countdown to a policy reversal this week, they are not constrained from acting on inflation if they judge it appropriate.

The Fed has deliberately removed inflation from consideration, asserting the steep rise this year is temporary, something that the governors cannot know and on which their own record of prognostication is poor.

In his comments on Wednesday, Chair Powell admitted that the price increases are likely to be higher and longer than they had anticipated.

British data is sparse this week and no competition for the BOE meeting.

Nonfarm Payrolls in the US for July will be issued this Friday, August 6. A strong result is capable of giving the dollar a boost and relieving some of the disappointment from the second quarter growth miss at 6.5%. Purchasing Managers Indexes for the service and manufacturing sectors in July could, if better than expected, revive some of the economic optimism lost to GDP.