Pound Sterling remains below 1.2500 amid caution ahead of Fed's policy decision

The Pound Sterling drops below 1.2500 as the US Dollar strengthens ahead of the announcement of the latest Fed policy decision.
In a light economic calendar week in the UK, speculation for BoE rate cuts is expected to drive the Pound Sterling.
Investors expect that the Fed will emphasize the need to maintain the current interest rate framework for longer.

The Pound Sterling (GBP) extends its downside below the psychological support of 1.2500 against the US Dollar (USD) during Wednesday’s early American session. Due to the light economic calendar in the United Kingdom, the volatility in the GBP/USD pair all comes from the side of the US Dollar as the United States faces a data-packed week, starting with the Federal Reserve decision (Fed) later on Wednesday.

The Pound Sterling’s valuation will solely be impacted by the Bank of England (BoE) expectations for interest-rate cuts. Financial markets speculate that the BoE could opt to cut borrowing costs in the June or August meetings. Traders have priced in rate cuts soon as BoE Governor Andrew Bailey said he is confident that headline inflation will come down to 2% in April. In March, UK inflation stood at 3.2%.

The recent steep correction in the GBP/USD pair reflects uncertainty among investors ahead of the Fed interest rate decision, which will be announced at 18:00 GMT. The Fed is expected to maintain interest rates steady and to give hawkish rhetoric, as recent inflation data suggests persisting price pressures, making it difficult for policymakers to gain confidence that price growth will sustainably return to the 2% target. This scenario of higher interest rates in the US improves the appeal of the US Dollar and weighs on other currencies whose central banks are seen cutting rates earlier than the Fed.

Daily digest market movers: Pound Sterling drops, US Dollar edges down on weak Manufacturing PMI

The Pound Sterling corrects sharply to 1.2480 against the US Dollar as investors brace for the Federal Reserve’s monetary policy decision. The CME FedWatch tool shows that traders see interest rates remaining unchanged in the range of 5.25%-5.50% for the sixth time in a row. Though no action is expected on borrowing rates, investors will keenly watch for the interest rate outlook by looking at the Fed’s statement and Chairman Jerome Powell's press conference.
The Fed is expected to support the “higher for longer interest rates” argument as a recent batch of inflation indicators has suggested that progress in inflation declining to the 2% target has stalled.
After higher-than-expected Consumer Price Index (CPI) and core Personal Consumption Expenditure Price Index (PCE) for March, Q1 Employment Cost Index also beat estimates by a strong margin. The index rose by 1.2%, higher than the consensus of 1.0% and the prior reading of 0.9%. Higher Employment Cost is generally driven by strong wage growth, which leads to an increase in consumer spending and fuels inflationary pressures.
Meanwhile, the US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, falls slightly from a two-week high of 106.50 after strong ADP Employment Change and weak US ISM Manufacturing PMI data. The ADP report shows that US private employers recruited 192K jobs, higher than the estimates of 175K and the former reading of 184K.
The ISM showed that the Manufacturing PMI fell sharply to 49.2 from the consensus of 50.0 and the prior reading of 50.3. The factory data remained below the 50.0 threshold, which itself is a sign of contraction. New Order Inflows dropped significantly to 49.1 from 51.4 in March, suggesting a weak demand outlook, which could be considered as the consequence of higher interest rates by the Fed.

Technical Analysis: Pound Sterling remains below 1.2500

The Pound Sterling falls sharply against the US Dollar after failing to extend its upside above the crucial resistance of 1.2570. The GBP/USD pair also fails to sustain above the 20-day Exponential Moving Average (EMA) around 1.2510, indicating that the near-term outlook is still uncertain.

The neckline of the Head and Shoulders (H&S) pattern has acted as a strong barrier for the Pound Sterling bulls. On April 12, the Cable experienced an intense sell-off after breaking below the neckline of the H&S pattern plotted from December 8 low around 1.2500.

The 14-period Relative Strength Index (RSI) oscillates in the 40.00-60.00 range, suggesting indecisiveness among market participants.

Pound Sterling FAQs

What is the Pound Sterling?

The Pound Sterling (GBP) is the oldest currency in the world (886 AD) and the official currency of the United Kingdom. It is the fourth most traded unit for foreign exchange (FX) in the world, accounting for 12% of all transactions, averaging $630 billion a day, according to 2022 data. Its key trading pairs are GBP/USD, aka ‘Cable’, which accounts for 11% of FX, GBP/JPY, or the ‘Dragon’ as it is known by traders (3%), and EUR/GBP (2%). The Pound Sterling is issued by the Bank of England (BoE).

How do the decisions of the Bank of England impact on the Pound Sterling?

The single most important factor influencing the value of the Pound Sterling is monetary policy decided by the Bank of England. The BoE bases its decisions on whether it has achieved its primary goal of “price stability” – a steady inflation rate of around 2%. Its primary tool for achieving this is the adjustment of interest rates. When inflation is too high, the BoE will try to rein it in by raising interest rates, making it more expensive for people and businesses to access credit. This is generally positive for GBP, as higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls too low it is a sign economic growth is slowing. In this scenario, the BoE will consider lowering interest rates to cheapen credit so businesses will borrow more to invest in growth-generating projects.

How does economic data influence the value of the Pound?

Data releases gauge the health of the economy and can impact the value of the Pound Sterling. Indicators such as GDP, Manufacturing and Services PMIs, and employment can all influence the direction of the GBP. A strong economy is good for Sterling. Not only does it attract more foreign investment but it may encourage the BoE to put up interest rates, which will directly strengthen GBP. Otherwise, if economic data is weak, the Pound Sterling is likely to fall.

How does the Trade Balance impact the Pound?

Another significant data release for the Pound Sterling is the Trade Balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports over a given period. If a country produces highly sought-after exports, its currency will benefit purely from the extra demand created from foreign buyers seeking to purchase these goods. Therefore, a positive net Trade Balance strengthens a currency and vice versa for a negative balance.

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