The GBPUSD has been somewhat range-bound recently, affected by bi-directional forces that have been equalising. Positive domestic factors have been offset by shifting global themes, leaving bulls and bears around equally matched. The upcoming data could give one side an advantage and push the cable in a new direction.
The market has recently been repricing the odds of a rate hike by the BoE this year, driven by a return to fiscal credibility and an economic rebound. While this has helped the pound gain against the dollar, the gains are at risk of being reversed if UK economic performance falters. This makes the upcoming UK data dump particularly important.
The Two Factors Guiding the BoE
While the Bank of England doesn’t have a full-employment mandate like the Fed, it pays close attention to the job market because labour market conditions have important implications for long-term inflation. If workers are getting constant pay rises, they will have more disposable income, driving demand. If supply doesn’t increase to match this demand (ie, there is relatively little economic growth), then there will be inflationary pressure.
On the other hand, if hiring is slow, employees will be hesitant to increase purchases and will instead hunt for bargains. This will cause downward pressure on inflation. This is why BoE Governor Andrew Bailey has been concerned about “slack” in the labour market during the first half of the year. High unemployment typically translates into lower inflation, and can cause a different kind of headache for the central bank: deflation.
Market Sees Higher Inflation Risk
For now, higher energy prices have been pushing up headline inflation, and the UK economy is seen as more sensitive to energy costs. Although there has been little evidence so far of “second-round” effects, markets are increasingly confident that long-term inflation will be affected by energy prices. The BoE would have to raise rates to get inflation expectations back in line, perhaps as soon as December.
However, this assumes a resilient economy capable of absorbing higher energy costs. Although fuel tends to be a low-elasticity product (meaning people can’t just stop buying it), a larger share of household bills going toward utilities and transportation could be offset by slower spending elsewhere. The result would be a slower economy, and inflation undershooting market expectations.
It’s the Economy
Once again, economic performance could be the key to the GBPUSD, particularly in light of Chancellor John Healy’s recent speech, his first major address since taking the top job at the Treasury. He pledged fiscal discipline and cost control, which helped reassure bond markets and cut the risk premium on UK debt. This sets a positive backdrop to attract investors who will support the pound, assuming the economy continues to grow.
The consensus among analysts is less optimistic, expecting July UK GDP to flatline, down from 0.3% a month earlier. The rolling 3-month average would slow to 0.3% from 0.4%. A beat here would help reassure investors and support the pound, while a miss could delay expectations for a BoE hike and weigh on cable.
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