The pound is expected to receive support from the Bank of England's cycle of interest rate hikes as long as the economy doesn't show signs of a slowdown.
As we have noted in today's review of the US dollar, the minutes from the June meeting published on Wednesday indicated that Federal Reserve officials expressed support for further tightening of monetary policy. However, the dollar is declining today. It is likely that this week could determine the dollar's direction until the end of the month when the next Federal Reserve meeting will take place on July 25-26.
Meanwhile, the pound has been the main winner of today's session. It is gaining strength against the US dollar despite the weak S&P Global report on business activity in the construction sector released this morning. This PMI assesses the business climate and conditions in the UK construction sector. Forecasts predicted a decrease in the June reading to 50.9 compared to 51.6 in the previous month, but the indicator turned out to be worse than expected, dropping below the 50 mark that separates growth from contraction in business activity to the value of 48.9.
More important indicators published yesterday showed positive dynamics. The final Services PMI from S&P Global for June remained at the same level of 53.7 and the Composite PMI stood at 52.8.
However, these values were worse than the previous ones (Services PMI: 55.2, 55.9; Composite PMI: 54.0, 54.9), indicating an emerging trend of slowing business activity.
The revised Manufacturing PMI from S&P Global published earlier this week strengthened from 46.2 to 46.5, against the forecast of 46.2 and the same preliminary estimate. However, it remains below the 50 threshold, indicating a slowdown in business activity in the UK.
The UK economy added +0.1% in the first quarter of 2023 compared to the previous rise of 0.1% and the same forecast. The year-on-year GDP growth in the first quarter was 0.2% (compared to the initial estimate of +0.2% and a forecast of +0.2%).
These figures, along with previously released macroeconomic data, indicate moderate growth that may turn into a slowdown at any moment.
However, economists believe that the pound can count on support from the cycle of interest rate hikes by the Bank of England until the economy shows clearer signs of a decline.
Economists are currently forecasting a higher peak in interest rates in the UK compared to the eurozone or the US. At the same time, considering the consequences of Brexit, economic growth in 2023-2024 will be weaker, and inflation will be higher than in the eurozone and the US.
At some point during the tightening of monetary policy concerns over a slowing economy may outweigh the risks of inflation. Many economists believe that this could happen in the second half of 2023.
Once the Bank of England stops the process of raising interest rates, the pound will lose support and start a reversal. Moreover, on the weekly chart, the GBP/USD pair has stopped near the key long-term resistance levels of 1.2800 and 1.2850, from which a reversal movement may start. It could be much more abrupt than the rise of GBP/USD initiated in September last year.
Back then, the Bank of England had to intervene in the financial market due to the sharp weakening of the pound caused by the unprofessional actions of the British government, led at that time by Liz Truss.
The Bank of England stated that it would conduct temporary purchases of long-dated UK government bonds "to restore orderly market conditions." Under the announced bond-buying program, the Bank of England will buy bonds with maturities of more than 20 years and with an initial purchase amount of up to £5 billion per auction.