The British pound to U.S. dollar exchange rate (GBP to USD) is driven by the performance of the U.K.’s economy, relative to that of the U.S. While the U.K. remains the strongest economy in Europe, is it enough to take the British pound higher?
Technical Analysis: GBP vs. USD
The outlook for the British pound to U.S. dollar exchange rate remained bleak after the financial crisis of 2008. The long-term chart below shows that the British pound is nowhere near its pre-recession peak of US$2.081. After the 2008 high, the British pound fell sharply, declining 35%.
The GBP-to-U.S. dollar exchange rate reached global financial recession lows near US$1.40 in January of 2009. Since that date, the British pound has partially recovered, but largely remained range-bound. From 2009 to 2015, the British pound has stayed between US$1.427 and US$1.716.
Chart courtesy of StockCharts.com
The short-term chart below shows the continued volatility in the British pound.
Chart courtesy of StockCharts.com
From July 2014 to April of 2015, the British pound lost nearly 15%. The pound sterling bottomed mid-April 2015, finding support at US$1.46. From there, the British pound rallied seven percent; reaching the most recent trading price of US$1.57. This was a strong move for a currency facing election uncertainty.
The cross-over of the 20-day moving average (blue line) above the 100-day moving average (red line) signals a reversal in the fortunes for the British pound. Longer-term traders will cheer this result, as the last time this happened the British pound rallied over 12%.
U.K. Economic Data
The recent rally provides evidence that the global currency markets have taken favorably to David Cameron’s May 7 election victory.
Or, has it been the U.K.’s robust economy growing at 2.8% in 2014, and set to expand 2.6% in 2015? Maybe the recent rally in the sterling is driven by a U.S. dollar that has lost steam. The greenback declined seven percent against a basket of currencies since March 2015. (Source: European Commission, last accessed May 14, 2015.)
Looking ahead, the GBP to USD forecast will be largely driven by the performance of the U.K.’s economy; as a likely result of the combination of above factors.
With the inflation outlook dangerously close to zero, economic growth remains painfully slow. This is similar to most of the developed world.
According to the Bank of England (BOE), inflation stood at zero percent in the U.K. as of March 2015. Optimistic economists at the BOE see inflation moving higher as food, energy, and other import prices reverse their current downward trend. (Source: Bank of England, May 13, 2015.)
At the moment, inflation remains subdued despite the BOE’s best efforts. The British central bank has kept its short-term benchmark interest rate, the Bank Rate, at 0.5% since March 5, 2009.
On top of that, similar to the Federal Reserve in the U.S., the Bank of England has continued to print money under the guise of asset purchases. The total assets purchased by the Bank of England, as of May 11, 2015, stood at ₤375 billion. (Source: Bank of England, May 11, 2015.)
Notably, the gross domestic product (GDP) forecasts were also disappointing. The Bank of England now sees the economy growing at 2.5% in 2015, down from the February forecast of nearly three percent. Looking further ahead, the GDP is set to hit 2.6% growth in 2016 and unemployment to reach 5.1%, from a high of 8.1% in 2011. (Source: Bank of England, May 13, 2015.)
GBP to USD Forecast
While U.K. economic data may be unimpressive on its own, it is strong relative to Europe and other developed nations like Japan, Australia, and Canada. So, the current rally in the British pound-to-U.S. dollar exchange rate, from US$1.465 to US$1.57, is justified. However, further substantial gains will be hard to come by.
I believe a 10% rally to July 2014 highs of US$1.70 will require higher U.K. inflation and a change in the ultra-loose stance currently taken by the Bank of England.
At the moment, the BOE sees the Bank Rate moving from 0.5% in 2015, to 0.9% in 2016, and even higher to 1.3% in 2017. If this materializes, the British pound can rally higher against the U.S. dollar. But, BOE’s decision to raise interest rates will be dominated by the inflation outlook. At the moment, we are nearly 200% away from the two percent mark. That’s a long way out.
Moreover, the U.S. Federal Reserve is set to increase interest rates before the end of 2015—putting further pressure on the British pound. Low domestic interest rates will act as a cap on a further rally in the British pound. Only solid economic fundamentals will take the British pound to U.S. dollar exchange rate higher.