How quickly the scenery changes on Forex. Just a week ago, it seemed that the British economy was heading for a soft landing. Inflation had been steadily slowing from its peak of 11.1% in October 2022, and other macroeconomic data indicated that the UK might avoid a downturn. However, the first acceleration of consumer prices in the last ten months and a sharp reduction in retail sales added turbulence to GBP/USD.
The rise of December's CPI to 4% and core inflation to 5.1% allowed the pound to find a bottom and bounce off it. Even disappointing retail sales statistics did not shake the market's confidence that the Bank of England would act slower than its counterparts in the USA and the Eurozone, softening monetary policy. This circumstance allows the sterling to be in the leading group among G10 currencies. Ahead – only the well-starting American dollar in 2024.
UK Inflation Dynamics
The 3.2% reduction in retail sales was the largest in the last three years. It led investors back to the idea of a recession. However, according to Capital Economics, the negative should be ignored, as the decline in retail sales is the result of customers using discounts on Black Friday in November. The chances of a soft landing have not diminished; it's just that before landing, the British economy's plane encountered turbulence.
It seems that the market holds the same position. It expects the repo rate to drop to the level of 4–4.25% by the end of 2024, which means a reduction of 100–125 basis points. This is less than the 150 basis points investors forecast for the federal funds rate.
The further fate of sterling will depend on the dynamics of inflation. If the December peak is a temporary phenomenon and the downward trend continues, GBP/USD risks losing its recent gains. Conversely, the continuation of the CPI rally will push back the expected repo rate reduction to a later period, which will be a tailwind for the bulls.
UK Inflation Forecasts
In the short term, investors should pay attention to the ECB meeting and the release of data on American personal consumption expenditures indices. The pound and the euro are pro-cyclical currencies, and their dynamics have much in common. It's no surprise that the unexpected acceleration of CPI in the UK helped not only GBP/USD but also EUR/USD. If the European Central Bank can convince investors of later terms for easing monetary policy, not only the regional currency but also the sterling will benefit.
Expectations of further slowing down of PCE, the inflation indicator preferred by the Fed, are putting pressure on the U.S. dollar.
Technically, on the daily chart, GBP/USD has formed a downward triangle. As long as the pair doesn't rise above its upper boundary and the pivot level of 1.2755, sellers maintain control. Therefore, a breach of the fair value at 1.269 and support at 1.2645 could provide grounds for sales.
