Forex Trading Library

Will Cable Weaken on US-UK Divergence?

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Tomorrow’s release of final GDP figures from the US and the UK are not expected to have a major impact on the markets, but they illustrate a trend that has been weighing on Cable. Depending on how the data goes, that trend could be intensified, and provide some important insight for swing traders. Day traders might be a bit disappointed this week as the holidays drain volatility.

With most of the major central banks expected to ease in the coming months, one of the main drivers of currency fluctuations is the timing for when that will happen. Generally, inflation has been coming down, but the economic performance between the countries has been dissimilar. And that could be the important variable to give currencies direction in the next couple of months.

Who Will Pull the Trigger?

Technically, the first major central bank to move towards easing was the SNB last week. But that doesn’t have an important impact on the GBPUSD. The question is when will the Fed and the BOE move interest rates, and there is a significant discrepancy between them. Both are seeing inflation come down. But the UK has a much higher rate, which means the expectation is for easing to start later.

The consensus is that the FOMC will vote to cut for the first time in June, while the BOE will do so in August. But there is also a discrepancy in their rhetoric. Fed Chair Jerome Powell acknowledges that rates will come down, but warns that they will stay relatively high. Meanwhile BOE Governor Andrew Bailey has said the market’s outlook for rate cuts this year is “reasonable”. Meaning that rhetorically, the BOE is more dovish than the Fed.

Where Will Cable Go?

Tomorrow’s data is expected to confirm that the UK had negative growth in the final quarter of last year, meaning it was technically in a recession. The US, on the other hand, is expected to confirm solid growth in the same quarter. Generally, central banks keep rates higher with a growing economy in order to prevent inflation from rising too much.

If the current trend continues, then the BOE will be under much more pressure to ease rates in order to support the economy than the Fed. If the economy goes too far into recession, then inflation can turn into deflation, a condition the central bank doesn’t want, either. That means the data is pointing to the dollar staying stronger than the pound once the rate cuts start.

Getting the Timing Right

If the US economy is growing, then inflation can remain a concern for the Fed. Which increases the risk that the expected June hike could be delayed. That would likely push up bond yields and support the dollar.

The UK has the opposite problem, as it risks staying in a recession, but it would take a substantially large economic rebound before inflation pressures start to threaten the downward path for rates. The economy suggests that there is less chance of a delay in rate cuts from the BOE. As Q1 data starts to come in over the next weeks, traders might reassess their expectations for the rate hike trajectory, and the balance of risk is inclined for a stronger dollar and weaker pound.

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