Pound at Risk on Diverging UK-US Growth and Policy

The United Kingdom's economy is anticipated to have stabilised, with diminishing productivity continuing to influence inflation considerations.​

A Spot of Weakness

The pound weakened slightly against the dollar last week. Comments from BOE Governor Andrew Bailey and stronger-than-expected US jobs data reduced investor expectations about gradual interest rate cuts by the Bank. Bailey indicated the Bank could "act more aggressively" to lower rates, which led traders to reduce bets on the pound gaining strength. However, in the same speech, he also warned that inflation may persist due to issues in the Middle East, and stating that monetary policy would ease faster if inflation fell faster is not novel.

Currently, the UK and the US have similar base interest rates. Markets predict a 97% chance the Bank will cut rates at its next meeting and an 81% chance the Fed will cut. Therefore, any divergence between cuts could disadvantage the pound. Britain's unexpectedly strong growth early this year appears set to slow. The UK economy is projected to expand by 1.0% this year versus the 2.7% growth anticipated for the US.

Coming to a Halt

The UK economy is forecast to report no growth in September GDP, as was seen in July following the General Election. This would reduce the 3-month average growth rate to 0.3% from 0.5%. Investors appear hesitant to assess the potential direction of fiscal policy under the new government. Business attitudes will be tested on October 30th when Chancellor Rachel Reeves announces the first Labour budget in over ten years. The extent of increased spending and taxes will be important to gauge potential inflationary impact.

Generally, slower economic growth implies less monetary circulation and reduced inflationary pressure. However, higher taxes and increased spending could have the opposite effect. Comments by the Governor last week, which preceded a drop in the pound, were followed by more cautious remarks from the Bank's Chief Economist suggesting inflation was likely to continue decreasing, but structural changes could sustain inflationary pressure. Regardless, flat GDP growth does put pressure on the Bank to favour easing - a challenge the Fed comparatively does not currently face, which could cause the pound to lose ground versus the US dollar.​

Towards Double Bottom

The pound's fall below 1.31 increases the possibility of further declines towards 1.30, where a double-bottom formation could lead to a rebound towards the swing highs of 1.3270 seen in late August. Should the interim resistance levels of 1.3115, 1.3176 and ultimately 1.32 be breached, the pair may complete the right shoulder of a potential head-and-shoulders pattern. Conversely, continued pressure could see cable move toward major support at 1.2875 if 1.2950 and 1.29 prove weak.​

Source: SpreadEx / GBPUSD

Key Takeaways

The UK economy is forecast to show no growth in September, reducing the 3-month average growth rate and putting pressure on the BOE to consider further interest rate cuts. While inflation may continue to decrease, structural issues in the global economy could keep prices elevated. Slower growth implies less monetary circulation and inflationary pressure domestically, but higher taxes and spending by the new government may have the reverse effect. This divergence from the US outlook could cause the pound to weaken versus the dollar if the BOE eases policy more aggressively than the Fed.​