A strong economy leads to a strong currency. This is a principle of fundamental analysis that remains unchanged. We all remember how the USD index surged from January to April, fueled by the revival of the American exceptionalism narrative. Investors expecting a slowdown in U.S. GDP were met with the opposite outcome, which set the U.S. apart from other countries and allowed the dollar to strengthen. Now, the UK has assumed a similar position to that of the U.S. earlier in the year. It should come as no surprise that GBP/USD is experiencing a rapid rally.
Following mixed reports on the labor market and inflation in the UK, positive data has started to emerge. The Gross Domestic Product (GDP) expanded by an impressive 0.6% in the second quarter, and retail sales jumped by 0.5% in July, with revisions showing an upward adjustment. This bolsters the belief that the economy will continue its steady progress in the third quarter. In the first half of the year, it outpaced the U.S. and confidently leads the G7.
G7 Economies' Performance
Strong macroeconomic data allows the Bank of England to proceed cautiously before continuing its monetary easing cycle, which began on August 1 with a reduction in the repo rate from 5.25% to 5%. Derivatives estimate the chances of a second BoE move in September at 37%. By the end of the year, borrowing costs are expected to decrease by 43 basis points, which is significantly less than the 93 basis points expected for the Federal Reserve. The different speeds of monetary policy easing provide favorable conditions for GBP/USD.
Political stability and growing global risk appetite also play into the pound's favor. Not long ago, investors had doubts about whether Keir Starmer's government could fulfill its promise to lead the UK economy to the top of the G7. The budget deficit seemed enormous, and the proposed tax hikes exerted downward pressure on the pound. However, recent macroeconomic data suggests that the Labour Party didn't have to exert much effort: when major competitors, led by the U.S., slow down, the UK gets a chance. So far, it's seizing that opportunity successfully.
I doubt that GBP/USD could have reached the 1.3 level without the rapid rally in U.S. stock indices. Both the S&P 500, Nasdaq, and the Dow Jones index saw their best weekly performance since November, as the market transitioned from fear to greed. While the specter of recession haunted investors in early August, by mid-month, it had been largely forgotten. Global risk appetite is growing, and the U.S. dollar is being sold off as a safe-haven asset.
The GBP/USD rally is also supported by expectations of signals pointing to the imminent start of the Fed's monetary easing, which are expected to be included in the minutes of the July FOMC meeting and Jerome Powell's speech at Jackson Hole.
Technically, on the daily chart, GBP/USD has managed to consolidate above its moving averages, trend line, and fair value level. This is a clear bullish signal and a reason to increase long positions formed from the 1.28 level. The target levels are 1.3015 and 1.3140.