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It has been another strong month for GBP/USD. The pair is up roughly 2.6% on the month at the time of writing, making sterling is the best performing G10 currency. GBP/USD, also sometimes referred to as “cable”, has rallied from around the 1.3800 level to monthly highs set earlier this week in the 1.4230s, since which time the pair has remained well supported as it ranges between the 1.4100 and 1.4200 levels. May’s rally puts cable back within striking distance of highs set earlier in the year (on the 23rd of February) at just above 1.4240. A break above this high would open the door, technically speaking, for a run at the 2018 high just below 1.4400. In the context of GBPUSD’s sharp recovery from post-pandemic lows around 1.1500, a near 25% recovery, another 1.5% rally to take it to fresh four-year highs does not seem like too much of a stretch to expect over the coming months.
Technical momentum seems to be on sterling’s side; GBPUSD’s 21DMA sits well above its 50DMA, which sits well above the pair’s 200DMA, with all three key moving averages pointing upwards, implying strong and consistent buying interest. Moreover, the pair’s 14-day Relative Strength Index (RSI), which currently sits at around 60% does not imply that cable is currently overbought (overbought is classified as when the RSI is 70% or above). That implies that recent gains have been more sustainable and that there is room for the pair to gain further without the risk of a sharp (perhaps profit-taking driven) pullback – these types of pullbacks are often seen when currency pairs are overbought according to the 14-day RSI.
So, enough discussion about the technicals. Fundamentally-speaking, why has GBPUSD been such a good performer this month, and more broadly, in recent months? Before we talk about sterling and the UK side of the equation, it must be first noted that most G10 currencies have posted decent gains against the US dollar this month, which has been hurt by the Fed’s ongoing dovish policy stance. In the face of inflation that is sharply rising (CPI hit 4.2% and PPI went above 6.0% in April), the Fed is unfazed and is maintaining the line that it expects the current sharp rise in prices to be “transitory” or one off. The Fed has emphasised that it remains primarily focused on keeping monetary conditions accommodative to help the labour market recover, a labour market which Fed members have been at pains to remind us remains a long way from the bank’s mandated goal of full employment. As a result of the Fed’s dovish stance on inflation and prioritisation of its employment goals over its inflation mandate, inflation expectations have remained elevated close to five-year high levels. This has kept US real yields under pressure, which is of course bearish for USD, given that lower inflation expectation adjusted yields reduce the incentive to hold money in USD versus other, higher yielding currencies. In somewhat less dovish developments, calls by FOMC members have been growing louder for the bank to pivot its stance towards a tapering of its QE programme. But markets were expecting the bank to signal this shift later in the year anyway, so tapering chatter has not been able to be of that much help to USD.
Talking of tapering and turning to UK/GBP fundamentals, the BoE earlier this month announced as expected that they would be reducing the weekly pace of their own asset purchases in order to stretch out their current QE remit until the end of the year, after which new purchases are likely to be halted (though reinvestment of maturing bonds is likely to continue for a time). That puts the BoE ahead of the Fed in the policy normalisation cycle and has thus been a positive for GBPUSD. Whether an earlier tapering of its bond buying programme will eventually lead to the BoE hiking interest rates ahead of the Fed remains unclear at this point; inflation in the UK, while likely to be high in the coming months the country continues to emerge from the pandemic and a surge of pent-up demand is unleashed over the summer, is unlikely to be as high as in the US. Consumers in the UK did not receive $2000 in stimulus cheques from the government like their American cousins. Markets are currently betting that the BoE and Fed will both start hiking cycles by the end of 2022.
More broadly, BoE aside, GBPUSD has been supported by extreme levels of optimism about the outlook for the UK economy over the coming months and for FY 2021. The UK’s vaccine rollout has been world leading and has helped the country to push its Covid-19 infection and death rates to amongst the lowest in Europe, whilst paving the way for a rapid, aggressive economic reopening, which really got firing in April when non-essential businesses were allowed to recommence trade. Restrictions were further eased in May and survey for the month point to an economy absolutely on fire right now. The fact that vaccines seem to work very well, including against much worried about (by the media anyway) Indian variant is helping to instil confidence in businesses that while the Covid-19 virus may prove endemic in the long-run, the need for draconian lockdowns and restrictions on basic civil liberties in order to prevent mass death in the UK is now permanently in the rear-view mirror. Most analysts suspect that UK GDP growth will outpace that of growth in the US this year (another factor that has been bullish for GBPUSD), though in fairness much of this is “catch-up” growth after the UK endured a much sharper drop in GDP in 2020 due to the pandemic than did the US.
In terms of what is next for GBPUSD; as long as the narratives of a dovish Fed that sees high inflation as transitory and not something to worry about and of a continued strong recovery in the UK economy remain intact, the path of least resistance remains towards further gains for the pair. As noted at the start, the technicals also remain supportive. GBPUSD bulls will likely be targeting a test and perhaps even break above the 2018 highs over the summer.
