The Pound Looks to the Future with Optimism

[Ben Graham]

The UK labor market report came out in line with expectations, and in some aspects even exceeded forecasts. Employment increased, the number of jobless claims decreased—an indirect sign of economic revival—and wage growth remains strong, which supports inflation expectations.

On Wednesday, the August inflation report will be published. After inflation rose to 3.8% y/y in July, the likelihood of the Bank of England continuing to cut rates has dropped significantly, and August is unlikely to change the bigger picture. Core inflation is expected to decrease from 3.8% to 3.6% y/y, while headline inflation is expected to rise to 3.9%, which, of course, does nothing to alleviate price pressures.

Confidence in continued moderate economic recovery is backed up by robust PMI data, especially in the services sector, while manufacturing remains relatively weak.

The Bank of England will hold its next monetary policy meeting on Thursday. The policy rate is expected to be maintained at 4.0%, with only two cuts forecast through the end of 2026. In order for rate cuts to begin, there needs to be signs of disinflationary pressure, and since there are none, the rhetoric may even turn more hawkish. The market still sees a high chance of a cut in November, but for that to happen, there must be clear signs of falling inflation, which makes the report highly significant for the pound.

Speculative positioning on the pound has hardly changed over the reporting week—the net short position stands at -$2.8B, but the estimated fair value is climbing higher, despite this bearish positioning.

GBP/USD has breached the 1.3580/95 resistance, as we expected last week, and is trying to build on this success, moving toward 1.3787. There are mainly two reasons for this: as usual, concerns about dollar weakness and the prospect of the Fed cutting rates faster than anticipated this summer, as well as expectations for a more hawkish Bank of England, since UK inflationary pressure is not abating. If things develop according to market expectations, the likely scenario is continued GBP/USD growth towards 1.3787. The 1.3580/95 area has turned into support, which now looks quite solid.

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