UK Feb GDP To Set Floor for Cable

The pound is recovering amid optimism about the Middle East, but whether the shift in central banks' outlook means further upside for sterling will likely depend on the British economy remaining solid.

The Upcoming Market-Moving Events

• Markets are hoping for a strong rebound in the UK economy in February to buffer the impact of the war in the Middle East.
• Futures indicate expectations of one to two BOE rate hikes this year, as inflation remains elevated due to higher energy prices.
• The pound could find support amid differences in central bank outlooks, as the Fed remains in an easing cycle.

BOE Still Expected to Hike Despite Optimism

Both the pound and UK stocks were higher on Tuesday after reports that the US and Iran would hold another round of talks later this week, raising hopes that the conflict in the Middle East might be over soon. The latest move left the GBPUSD above where it was at the start of the war, as investors priced in a new central bank scenario. Expectations for the BOE's future rate path have swung widely as the situation in the Middle East has evolved. In late February, markets expected two rate cuts this year, with a high likelihood that the first would be in April. At one point, futures suggested as many as four hikes by December, but as hopes grow that the conflict will be over soon, markets are settling into one or two hikes. While the BOE has adopted a wait-and-see attitude, markets are clearly expecting it to be much more hawkish now.

The issue is that even if the war is resolved quickly, higher fuel costs could linger, putting upward pressure on inflation. With consumer prices already rising faster than the BOE's target, the central bank will likely have to tighten policy to address the issue, at least in the short term. Generally, higher rates support the currency, but if the BOE raises rates by too much, it could stifle the UK's anaemic growth, which would actually drag the pound lower.  This is why the pound fell against the dollar last month, as traders worried that British economic growth would falter amid higher energy prices and higher interest rates. However, if the economy remains resilient as the BOE takes a more hawkish stance and potentially raises rates by 25bps, sterling could regain its strength. It could even have an advantage over the greenback as the BOE modestly raises rates while the Fed remains in a dovish cycle. That's why Thursday's monthly GDP could be important, as it sets the baseline for the economy before the impact of the war.

Cable Relying on a Growing Economy

The consensus among economists is that the UK's February monthly GDP will rise to 0.1% from 0.0% in January. Some analysts, like Deutsche Bank, are more optimistic, projecting a 0.2% monthly increase. This is based in part on notable improvements in the February PMI data. However, the concern is that the upward trend reversed in March, so investors are looking for a "high" mark that would give the British economy room to absorb the impact of the war in the Middle East. If that were the case, the market could continue to price in at least one rate hike this year, which would support cable. A disappointment in the data would likely leave the BOE outlook unchanged but weigh on investor sentiment for the pound, which could drag cable down in the process.

Following a 9-day winning streak from 1.3190 to 1.3590, the VWAP lines are expanding but are causing short-term rejections at each touch. With the cable above the major support at 1.3400 but below 1.3600, a short-term pullback could be expected, bringing into focus 1.3500 and 1.3470. A breakout above the round resistance, on the other hand, could open the door to 1.3700, but this scenario would require strong momentum just as the RSI hovers below overbought.

Source: SpreadEx | GBPUSD, Daily Chart