GBP/USD outlook: FOMC looms as UK inflation relief gives BoE room to wait

The next 24 hours or so could be quite important for the GBP/USD outlook as both the Fed and BoE decide on monetary policy. The focus will be on the Fed tonight and it will be interesting to see their response to the collapse in oil prices on the back of the US-Iran deal. The drop in oil has certainly added a dovish argument ahead of new Chair Kevin Warsh’s first rate decision. Should he go against market's hawkish expectations, this could weigh on the dollar. Meanwhile from the UK, the latest inflation figures have handed the BoE another reason to remain cautious at tomorrow’s MPC meeting. Headline CPI held steady at 2.8% in May, surprising expectations for a modest rise and reinforcing the view that inflation pressures remain contained despite the recent oil spike.

 

Fed guidance likely to be the key driver for dollar

 

The dollar enters the Fed’s decision with much of its recent resilience resting on expectations that policymakers remain open to further tightening. While markets have largely priced in a hawkish stance, the focus will be on how the new Chair Kevin Warsh frames the outlook.

 

The announcement of a US-Iran deal has weighed significantly on oil prices in the last few days, easing concerns about energy-driven inflation and strengthening the case for a less aggressive policy path. Yet rate markets continue to price some additional tightening by year-end, leaving the dollar vulnerable if those expectations are challenged. Meanwhile, Warsh’s press conference will follow the rate decision as usual, and markets will be listening to him quite closely.

 

My base case is that the Fed or its new chairman will not want to deviate too much from market pricing. But whether this will give the dollar bears the excuse to press the sell button remains to be seen. But if the Fed decides to remove any easing bias and maintain a cautious tone on inflation, that will likely keep the dollar stable.

 

Soft UK inflation data strengthens the case for patience

 

 

There was some surprise in UK inflation data this morning, causing the GBP/USD to ease lower a touch. A significant part of the story was food prices. Rather than rising, food costs declined on a month-on-month basis, mirroring trends seen across parts of Europe. This helped offset upward pressure from airfares and transport-related factors, preventing a broader acceleration in consumer prices. Producer price data also points to further easing in food inflation through the summer months, suggesting households may continue to benefit from lower grocery bills in the near term, barring another spike in energy prices.

 

How will the BoE respond?

 

For Bank of England’s policymakers, the key question is whether recent energy market volatility translates into more persistent domestic inflation. So far, there is little evidence that higher oil prices are feeding through into wider price pressures.

 

The Bank’s preferred measures of underlying services inflation remain relatively stable, albeit at high levels near 4%. Surveys of business pricing intentions suggest companies expect inflationary pressures to remain broadly unchanged over coming months. The BoE remains highly sensitive to so-called second-round effects, where higher energy costs trigger broader wage and price increases across the economy. At present, those risks appear limited.

 

Against this backdrop, the Bank of England looks set to leave interest rates unchanged, as widely expected.

 

For traders, the accompanying guidance may prove more important than the rate decision itself. Any indication that policymakers remain comfortable with the disinflation trend could reinforce expectations that the next move in rates will ultimately be lower rather than higher.

 

GBP/USD outlook: How will the pound respond?

 

Now that is not necessarily a negative scenario for the pound. While that may sound counterintuitive, the rationale is that the recent oil-driven hawkish repricing clearly failed to provide the pound any meaningful support. So why would it matter now that those rate hike expectations are pared back down?

 

As a result, I think the GBP/USD outlook will take a positive boost should the Fed turn out to be relatively more dovish than market expectations, while not reacting much to the BoE’s decision.

 

Technical GBP/USD outlook and key levels to watch

 

The GBP/USD remains in consolidation mode ahead of the FOMC and Bank of England rate decisions, which is hardly a surprise.

 

 

The trend for the GBP/USD is not particularly clear at this stage, with price trading around the 200-day moving average without making any significant moves in either direction.

 

Short-term resistance comes in around 1.3450, followed by the 1.3500 handle. A break above that would be a positive development and could pave the way for a rally towards 1.3658, the most recent high.

 

On the downside, support comes in around 1.3350, followed by 1.3300. A break below that could expose the 1.3200 handle for a retest.

 

All told, GBP/USD remains a level-to-level market as things stand.

 

However, depending on the outcome of the policy decisions from the two major central banks this week, we could see a clearer technical direction emerge for the currency pair moving forward.

 

For now, patience remains the name of the game.

 

 

 

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R