Has the pound fallen too profoundly? In September, retail sales in the UK grew by 0.3% month-on-month and 3.9% year-on-year, surpassing Bloomberg's expert forecasts. The composite business activity index is expected to accelerate in October and remain above the 50 mark, indicating expansion for the 12th consecutive month. The UK economy is still standing strong, so why sell GBP/USD?
The UK is somewhere between the US and the Eurozone. It shares with the currency bloc the first decline in inflation below the 2% target in three years and its export-oriented nature, making the pound a pro-cyclical currency sensitive to global economic trends. Unsurprisingly, the increasing risks of Donald Trump's victory in the November presidential elections and the associated resurgence of trade wars have caused GBP/USD to plummet.
Inflation Dynamics in the UK
On the other hand, the UK is not as weak as the currency bloc. Unlike in continental Europe, the country's risk of slipping into deflation is low. This would require weak domestic demand and a fragile economy overall. The UK does not fit this description. The Bank of England might proceed with monetary easing at a pace similar to the Federal Reserve's, but certainly not as quickly as the European Central Bank. Following the release of September CPI data, the futures market raised the likelihood of two acts of monetary easing by the BoE in 2024 from 50% to 90%, which led to a drop in GBP/USD.
Moreover, the UK labor market shows no signs of weakness. Unemployment remains relatively stable, employment is rising, and wages across various categories show even greater resilience than in the US.
Wage Dynamics Across Different Employee Categories
This suggests that inflation in the UK has a higher chance of accelerating than in the Eurozone. As a result, the Bank of England's forecasts could be fulfilled, and the expected pace of monetary policy easing might slow down. This should support sterling. However, amid the resurgence of the "Trump trade," the pound will likely remain under pressure, at least until the US presidential elections in November.
Investors rely on past patterns and often look back to 2016 when Donald Trump first took office. Consequently, there is high interest in bank stocks, small-cap companies, and the US dollar. Markets believe that introducing additional import tariffs and the resumption of trade wars will slow the global economy and increase demand for the dollar as a safe haven. Additionally, renewed supply chain disruptions could accelerate inflation, forcing the Fed to maintain higher interest rates.
Technically, on the daily GBP/USD chart, the bulls' inability to return to the 1.308-1.310 resistance zone and break above it is a sign of their weakness and a reason to sell, targeting levels of 1.290 and 1.284.
