In just a year, GBP USD rate went on a wild ride, nearly hitting parity, soaring to a 16-month high, and then taking a nosedive to a six-month low. Such a rollercoaster isn't a common sight in the world of Forex. Let's dive into this to figure out what happened and what might happen next.
No matter how hard the Bank of England tried to mimic the Federal Reserve's hawkish stance and convince the markets that the tightening of monetary policy wasn't done yet, it fell flat. The pause following 14 consecutive repo rate hikes seemed like the end of the road for monetary tightening. Eventually, the talk of the governor of the Bank of England, Andrew Bailey, about the possible continuation of the rise came across as a bluff. Consequently, GBP USD quotes took a plunge to a six-month low, and things started resembling the events from a year ago.
Back in September 2022, the pound was on the verge of hitting parity with the US dollar following Liz Truss government's mini-budget presentation. The hefty fiscal stimulus didn't align with the Bank of England's tightening monetary policies, eroding confidence in the Cabinet, followed by the Prime Minister's resignation. That's when the pound recovery journey began. By July, the pair reached its peak as fears of a British economic downturn failed to materialize, and the derivatives market anticipated a repo rate hike to 6.4%.
The spike in borrowing costs was notably higher than in other major global economies, positioning the pound as a strong contender among G10 currencies. However, the situation took a sharp turn in the middle of the summer. The British economy started sputtering and fell into stagflation, with the implied ceiling on the repo rate dropping to 5.5 percent. In contrast, the US showed remarkable resilience to the Fed's aggressive monetary tightening. The divergence in GDP growth fueled the downtrend of GBP USD.
Following the September meeting of the Bank of England, the derivatives market slashed the odds of the monetary tightening cycle continuing down to 50%. Investors realized that the federal funds rate rising was a more plausible scenario than a repo rate hike. Consequently, the gap between economic growth and monetary policy divergence grew wider. The pound slumped to its lowest point since mid-March, and it doesn't appear to be out of the woods yet. BofA, HSBC, Nomura, and Goldman Sachs all anticipate GBP USD to fall to 1.18. While parity might not be in sight, it does seem like sterling's prime days are in the rearview mirror.
These challenging times may persist, as the US dollar boasts other advantages. Among them is its status as a safe-haven asset, sought after when global risk appetite wanes and stock indices take a tumble. Additionally, the looming threat of a US government shutdown only adds to the uncertainty, further fueling investors' interest in safe-haven assets.
This article was written in cooperation with TradingView