Downside Risks For GBP/USD And Economic Divergence
Given the recent pullback in GBP/USD, we see further downside for the pound in the coming weeks. The rally based on US-Iran news appears to be exhausted, and underlying economic weakness in the UK is becoming the dominant factor. Our target for the currency pair is 1.3100. The divergence between the US and UK economies is widening. Recent US retail sales figures surprised to the upside at +0.5%, whereas the latest UK consumer confidence survey has fallen to a 12-month low of -25. This supports a view of a stronger dollar against a weakening pound. Slowing UK growth has forced the market to reduce its expectations for Bank of England rate hikes. Swaps markets have priced out a full 25 basis point hike, now anticipating just 40bps of tightening over the next year. While falling energy prices are a global factor, the latest dot plot from the US Federal Reserve still signals a greater resolve to maintain its policy path.Political Risks And Market Strategy
The UK political scene adds a layer of risk that we believe is underappreciated. All eyes are on the Makerfield by-election scheduled for June 18. The potential for a victory by Andy Burnham could introduce significant political uncertainty and challenge the current Labour leadership. This political risk makes sterling options attractive. Implied volatility for one-month GBP/USD options has already climbed from 7.5% to 8.2% in the last week, and we expect this trend to continue as the by-election nears. We believe buying GBP/USD put options with a strike near 1.3150 expiring in early July is a prudent way to position for a decline. While the Bank of England’s focus on inflation should provide a floor and prevent a disorderly slide, it is unlikely to be enough to reverse the negative sentiment. The path of least resistance for GBP/USD appears to be lower.Start trading now — click here to create your real VT Markets account.
