The Pound US Dollar exchange rate briefly hit its best levels since last week on Wednesday, as markets became concerned that slower inflation in the US would lead to the Federal Reserve downgrading its 2017 interest rate outlook. However, GBP USD dropped from these highs following the Fed meeting and trended near the week’s opening levels of 1.2743 again.
Pound (GBP) Limp ahead of Bank of England (BoE) Decision
Pound investors have had little to be excited about this week, as UK political concerns persist and this week’s domestic data has refreshed concerns about Britain’s 2017 economic outlook.
Following last week’s UK general election which ended in a hung parliament, the Conservative party appears to be moving ahead with running a minority government or potentially a coalition with Northern Ireland’s Democratic Unionist Party (DUP).
Conservative and DUP talks are ongoing, but developments in this as well as how Brexit negotiations could be affected by the new weaker government will continue to influence the Pound outlook.
Wednesday’s UK wage growth stats from the three months into April worsened Britain’s economic outlook. As inflation continues to surge to 3% but wage growth fails to keep up, analysts expect consumers will face a concerning ‘pay squeeze’.
If citizens aren’t being paid enough to comfortably buy increasingly pricey consumer products, spending will drop and Britain’s consumer-facing economy could slow down later in the year.
UK retail sales data disappointed on Thursday, as May saw the slowest rate of UK growth since 2013. This indicated that inflation was indeed hitting spending.
The Bank of England (BoE) policy decision on Thursday will also have an impact on the longer term Pound US Dollar exchange rate, particularly depending on the bank’s views on UK inflation and growth.
Investors had been hoping that as UK inflation continues to surge, the BoE would be pressured into tightening UK monetary policy. However, amid other political and economic uncertainties this is unlikely.
If the bank remains cautious on Thursday and indicates that Britain’s economy could slow due to the ‘pay squeeze’ in 2017, the long-term Pound outlook will worsen further.
On the other hand, if the bank remains confident in Britain’s economy despite rising inflation the Pound could be offered some relief.
US Dollar (USD) Recovers as Fed Remains Optimistic
Despite a poor US inflation report on Wednesday, the Federal Reserve hiked US interest rates as was expected. This was the second rate hike of 2017.
As investors and analysts were widely expecting the Fed to hike US interest rates this week, this was already largely priced into the US Dollar. USD saw minimal benefit from the hike itself.
It was the Federal Reserve’s outlook that made ‘Greenback’ traders a little more optimistic. While the Fed acknowledged that inflation had slowed in recent months and would likely not meet its 2% target in the next year, it noted that the US economy was still strengthening.
The bank also confirmed that it would be winding back parts of its quantitative easing (QE) scheme and reducing the balance sheet, indicating to markets that the Fed was confident about normalising monetary policy.
The Fed increased its US Gross Domestic Product (GDP) outlook for 2017 to 2.2% and unemployment is expected to decline more than expected. 2018 forecasts were unchanged.
Overall, the Fed seemed unfazed by this week’s disappointing inflation data and indicated it was still on track for a third interest rate hike before the end of the year.
However, analysts and many investors are uncertain if the Fed will manage a third 2017 rate hike unless inflation improves or political jitters soften. According to the CME Fedwatch tool, bets of a third rate hike this year are only at 35%.
This, as well as the US Dollar outlook, will shift in the coming weeks and months depending on the strength of US data.
GBP USD Interbank Rate
At the time of writing this article, the British Pound US Dollar exchange rate trended in the region of 1.2710. The US Dollar to Pound exchange rate traded at around 0.7867.
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