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GBP/USD Rebound to Accelerate on Sticky UK CPI, Shift in FX Sentiment

GBP/USD Rebound to Accelerate on Sticky UK CPI, Shift in FX Sentiment

2016-03-19 23:27:00
David Song, Currency Strategist
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GBP/USD Rebound to Accelerate on Sticky UK CPI, Shift in FX SentimentGBP/USD Rebound to Accelerate on Sticky UK CPI, Shift in FX Sentiment

Fundamental Forecast for British Pound: Bullish

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The near-term rebound in GBP/USD may gather pace in the week ahead should the key developments coming out of the U.K. economy put increased pressure on the Bank of England (BoE) to normalize monetary policy sooner rather than later.

Despite expectations for a 1.0% decline in U.K. Retail Sales, stickiness in the core Consumer Price Index (CPI) may heighten the appeal of the British Pound and generate a larger recovery in GBP/USD as the BoE argues that the next move will be to normalize monetary policy. Indeed, the U.K. referendum is likely to keep the Monetary Policy Committee (MPC) on the sidelines throughout the first-half of 2016 as the board votes unanimously to retain the current policy in March, but signs of stronger-than-expected price growth may encourage Governor Mark Carney and Co. to adopt a more hawkish tone over the coming months especially as the central bank sees a risk of overshooting the 2% inflation-target over the policy horizon.

At the same time, the recent weakness in the greenback may contribute to a further appreciation in GBP/USD as the Federal Reserve cuts its growth and inflation forecast, with central bank officials laying out a more gradual path for future interest rates. Even though the U.S. economy approaches ‘full-employment,’ Fed Chair Janet Yellen may further tame interest-rate expectations and endorse a wait-and-see approach for most of 2016 as the central bank continues to monitor the external risks surrounding the region. As a result, the dollar stands at risk of facing additional headwinds over the near to medium-term as market participants scale back bets for higher borrowing-costs this year.

In turn, a slew of positive U.K. data prints accompanied by waning U.S. interest-rate expectations may fuel a further short-squeeze in GBP/USD as there appears to be a shift in market positioning. According to the DailyFX Speculative Sentiment Index (SSI), the FX crowd has been net-long GBP/USD since November 19, but recent updates have shown a material shift in retail bias as the ratio continues to narrow from the extreme readings registered in January.

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