The GBP/USD exchange rate is bracing for volatility as the UK releases the August inflation report ahead of the Federal Reserve and Bank of England (BoE) interest rate decisions. It was trading at 1.3165 on Wednesday, a few points below the year-to-date high of 1.3267.
UK inflation data and BoE
The Office of National Statistics (ONS) will publish the latest inflation report on Wednesday, a day before the BoE delivers its monetary policy decision.
Economists expect the data to show that the headline inflation rose slightly in August. The CPI is expected to move from minus 0.2% in July to 0.3% in August. On an annual basis, the CPI is expected to have remained at 2.2%.
Core inflation, which excludes the volatile food and energy prices, is expected to rise from 3.3% in July to 3.6% in August.
These numbers will come out a week after the UK published an encouraging jobs report, which showed that wage growth remained strong in July.
If analysts are accurate, then these numbers will reduce the chances of a rate cut by the Bank of England when it concludes its two-day meeting on Thursday.
The data will also mean that the UK’s inflation remains stubbornly high and is above the bank’s target of 2.0%.
Economists believe that a series of interest rate cuts will follow this week’s pause as the bank works to stimulate an economy that is slowing.
However, some analysts believe that the bank will deliver a 0.25% rate cut in this meeting. Data by Refinitiv shows that odds of a cut have risen to about 35%.
Some economists favor a cut because of the soggy summer activity, service inflation, and the recent wage growth numbers. Also, some analysts believe that a rate cut will help to reduce sterling’s rally, which may make the UK attractive as an exporter.
Federal Reserve decision ahead
The next important GBP/USD news will come from the United States where the Federal Reserve is expected to deliver its first cut in over four years.
Conditions for a cut are appropriate because of the recent economic data from the US. First, a report earlier this month showed that the labor market is worse than previously believed. The economy created 818k fewer jobs in the 12 months to March.
The unemployment rate has remained above 4% while the number of monthly jobs additions has been weak. In its nonfarm payrolls data, the BLS has revised the figures downwards in most months this year.
Second, US inflation is moving in the right direction. A report released last month showed that the headline Consumer Price Index (CPI) dropped to 2.5% in August, the lowest level in over two years.
Inflation will likely continue moving downwards because of falling crude oil prices. Brent, the global benchmark, has dropped to $73 while the West Texas Intermediate (WTI) has moved to below $70. This means that transportation costs, which impact most things, will continue moving downwards.
Therefore, traders have raised bets that the Fed will cut interest rates by 0.50%. Just this week, Senator Elizabeth Warren and some of her Democratic colleagues, pressured the bank to deliver a 0.75% rate cut, which is highly unlikely to happen.
Traders in Polymarket, a leading crypto-enabled prediction market, have raised their expectation of a 0.50% rate cut.
However, not all analysts are fully convinced of a 0.50% cut. In a note, those at ING predicted that the cut will be 0.25% while cautioning that it would be a close call. Their statement said:
“We favoured a larger move as an insurance policy against the prospect of more significant job weakness in the future, but the most recent jobs report was not as weak as feared, and August core CPI came in hotter than hoped at 0.3% MoM. Given this backdrop, we have to admit that 25bp looks like the most probable outcome.”
GBP/USD technical analysis
GBP/USD chart by TradingView
The GBP/USD exchange rate has been in a strong bull run in the past few months. It bottomed at 1.2290 in May and then staged a strong comeback to a high of 1.3268 in August. Along the way, the pair formed an ascending channel pattern.
It has also moved slightly above the crucial resistance level at 1.3141, its highest swing in July last year. The pair has remained constantly above the 50-day and 25-day Exponential Moving Averages (EMA) while the Relative Strength Index (RSI) has moved slightly above the neutral point.
The pair has also formed a small double-top chart pattern, a popular reversal sign. Therefore, the likely scenario is where the pair retreats since the Federal Reserve rate cut has been priced in by market participants. If this happens, the pair could drop to the next psychological point at 1.3000.
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