The pound's mid-week jump suggests that it is too early to write it off. It could still show a powerful rally before the end of the year. Technical analysts are in favor of further gains in the GBP/USD pair. The fundamental picture is mixed but at the moment the bias is in favor of the pound. Next week will be a turning point for many currencies, including the pound. The meetings of the central banks will be important in terms of shaping the mood of the world markets.
Credit Suisse strategists also expect an extension of the rally. According to them, the call comes as pound sterling enters a period of consolidation having endured a multi-week period of appreciation against the dollar. Several people can't fathom how it happened, the mood on the pound was initially negative, and now the rally is hinting at an extension.
After all, the consensus narrative on the UK economy is that it has fallen into recession and will be among one of the worst-performing developed market economies in 2023.
But this is the nature of consensus expectations: they result in trades that get too crowded and are prone to notable reversals. That's why it's a good idea to focus on technical analysis and strategy, as it will help you look at the price action for clues as to future direction.
The technical analysis suggests that GBP will further appreciate until it reaches the May highs at 1.2670 and above.
How will it happen?
Before the rally, we expect a consolidation phase in the near future. In general, as strategists note, this is a temporary phenomenon. Next, bulls will storm the resistance at the level of 1.2408.
The next upside target to test would then emerge at 1.2520, and eventually, it may surpass the May high at 1.2670. If it manages to cross this level, then it might even rise to 1.2760.
We should not disregard the fact that it might go the opposite direction. It is worth tracking the movement around the level of 1.2050. A close can see a deeper setback to a much stronger support at 1.1900-1.1875.
Although tactical traders are looking to respect momentum and price direction, those analysts who are more inclined to look at UK economic fundamentals retain a bearish bias towards the pound.
Growing macro risks will hurt the pound, and the current rally might prove to be a temporary bounce. At the same time, the dollar has also found renewed strength in recent trade, it could hint at a rally if the Federal Reserve supports it.
Meanwhile, all is not so smooth in the UK, with the economy facing a period of strikes in December.
"Hundreds of thousands of workers across the country are going to strike across industries in disputes over pay, pensions, jobs and conditions. Among other, they include rail staff, bus drivers, nurses, civil servants and postal workers. Given that this is happening just weeks before Christmas, we could see a noticeable hit to an already weak economy," says Fawad Razaqzada, Market Analyst at City Index.
The economy contracted in the third quarter and all signs point to another quarterly fall. Next year will be tough due to the effects of inflation and interest rate hikes.
Capital Economics expects inflation and interest rates will be a bit higher in 2023 than currently assumed. This explains why they expect a deeper recession, which will entail a 2% fall in real GDP.
Rabobank strategists are still pessimistic about the pound. "We continue to view GBP as vulnerable and see a strong risk that cable will spend much of next year below 1.20," says Jane Foley, Senior FX Strategist at Rabobank.
Central bank and currency parade
For now, as I mentioned above, the pound could consolidate as investors prepare for next week's packed calendar.
Key near-term events to watch are the release of U.S. inflation data on December 13 where an unexpected rise in prices will almost certainly see the dollar rip higher.
The Fed rate hike decision then falls on December 14, providing another crucial moment for the pair.
A 50 bps hike is already expected, so the most important thing will be the updated guidance and projections for future rate hikes. A message that rates would be required to rise substantially higher than previously anticipated would ignite dollar gains.
The BoE meeting then falls on December 15 where a 50 basis point hike is anticipated. Again, it is guidance that will determine the market reaction, although there will be no new forecasts issued by the central bank's economists.
Meanwhile, any signs that the BoE will continue to raise rates should support the pound.
"After next week's move, the BoE will add another 50 bps in the first quarter, then by 25 bps in the second. Meanwhile, median forecasts show the bank rate peaking at 4.25%. Forecasts for the final rate ranged from 3.50% to 4.75%," according to the latest Reuters survey.
GBP/USD struggled in the 1.2230 area on Thursday and 1.2260 on Friday. If bulls manage to push the pair to settle above this area, positive momentum will drive further gains, so the pair can aim for 1.2290-1.2300.
In case the pound breaks down at 1.2230, it will remain in a sideways position between this zone and 1.2150 until next week's important events.
