Pound / Dollar Declines Forecast to be Shallow

Sterling, after rising to just short of GBP/USD 1.5500, has corrected visibly and returned into the 1.51 area.

The main culprit for the decline was a disappointing set of manufacturing data from the UK economy which suggests economic growth may be slowing.

We don’t expect any significant rebound to shape up for the pound to dollar exchange rate this week as we have elections on Thursday. The uncertainty around the event could keep USD under pressure.

That said, if a notable Conservative victory shapes up, the business-as-usual implications of such an outcome would likely prompt a GBP rally.

The pound to dollar exchange rate is at 1.5147 at the time of writing.

The exchange rate is still significantly higher than it was at the start of April which saw the rate a great deal further down at 1.48.

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It’s All About the Dollar

The ability of the British pound to advance against the Greenback since mid-April comes despite electoral uncertainty dominating the near-term horizon.

Ultimately we are of the opinion that the much-hyped electoral period should only inflict increased volatility at the most - this is no game-changer.

The USD has seen a return to strength at the start of May, "It's a little too early to tell if this is truly the start of a return to the USD bull trend, but in the near term we expect some follow through buying with support still coming from US yields. While we expect a supportive payroll number, a poor release will see the USD and the bond market turn around very quickly," say Lloyds Bank.

So what is important for the GBP v USD exchange rate?

We would suggest the US dollar side of the equation is the most important element for this currency pair.

The performance of the US economy in the first quarter of 2015 was significantly worse than expected leading to a decline in the dollar and allowing the pound sterling to recover in strong fashion:

“With the growth gap between the US and the rest of the world temporarily narrowing, we think that the USD correction has a bit more room to run,” says Hans Redeker at Morgan Stanley.

If this fundamental viewpoint held by Morgan Stanley is correct then we could well see the GBP-USD pair finding support and any weakness proving temporary.

Dollar Weakness: How Long Will it Last?

An interesting factor to watch is the strong performance in Asian stock markets, something that has seen dollars sold off as global investors seek to cash in on the strong performance.

“The change in Asian equity sentiment is also a temporary game-changer for USD; should that persist, we believe that DXY is likely to correct to the 93.00 area before finding support,” says Redeker.

The DXY is the US dollar index - an index that measures the overall performance of the US dollar based on moves in the likes of GBP-USD, EUR-USD, AUD-USD etc.

Moves in the dollar index will therefore obviously have implications on the likes of the GBP-USD.  

“That said, we continue to view this USD decline as a correction within a secular USD bull market,” says Redeker.

Morgan Stanley is not the the only major bank forecasting an eventual continuation of USD strength.

BMO Capital point out that we are at the beginning of a major secular USD strengthening period - cycles that historically last 7 years or so.

As such, the argument for USD strength resuming in 2015 remains alive.

But Sterling Also Faces a Period of Strength

However, keep in mind that the British pound is expected to be well supported owing to the outperforming UK economy.

Economic strength should ultimately lead the Bank of England into an interest rate raising cycle; rising interest rates = stronger exchange rates.

As such, we would expect much of the forecast USD strength to be felt elsewhere, with the euro absorbing much of the pressure.

For the exchange rate, the picture should become clearer next week, with the  publication of the BoE’s Inflation Report on 13 May.

“In case of a downward revision of inflation forecasts, or possibly of growth projections as well, the chances of an initial bank rate hike this year would become even slimmer, and sterling would weaken against the dollar towards GBP/USD 1.45/1.44,” says Asmara Jamaleh from Intesa Sanpaolo.

We agree with this observation - those watching the foreign exchange markets to make a pound sterling exchange should focus on the Bank of England's interest rate decision making process for clues on the longer-term setup.