GBP/USD Weekly Forecast: The Bank of England is set to get stuck between the rock and a hard place with wages decelerating and inflation ticking up

• The UK government losing key ministers last week sees plans for smooth Brexit thrown into disarray. 
• The US President Trump criticized the UK Prime Minister May for killing the option to deal with the US as her government opts for hard Brexit strategy. 
• With the headline and core inflation seen picking up and the UK wages decelerating, the Bank of England is set to get stuck between the rock and the hard place. 
• The GBP/USD faces major support at around 1.3100 with a break below targeting 1.2670 Fibonacci support.

The Brexit-related headlines formed the curve for Sterling in the second week of July with Brexit whitepaper first boosting the confidence before two key UK government officials left their posts sending Sterling lower.

The GBP/USD was boosted last Monday on news of Theresa May’s Brexit whitepaper gaining government’s support with the currency pair rising to a 2-week high of 1.3360 after the Brexit minister David Davis stepped down and was quickly replaced by Dominic Raab. The resignation of the UK Foreign secretary Boris Johnson later on Monday nailed the coffin for Sterling that fell as low as 1.3170 in a move that has been the signature trend for the rest of the second week of July.

Sterling fell some 260 pips off the peak at 1.3360 to 1.3100 on Friday as the political development had a greater influence on the currency pair than a tentatively optimistic macro picture of the UK economy. 

Even the US President Donald Trump added the heaviness for Sterling saying the UK Prime Minister Theresa May shut the door in dealing with the US because of opting for the hard Brexit strategy with the EU.

“If they do a deal like that, we would be dealing with the European Union instead of dealing with the UK, so it will probably kill the deal,” Trump is quoted to say in the exclusive interview with the Sun while visiting the UK.

Meanwhile, the UK growth confirmed solid recovery of the UK economy after the first-quarter adverse weather-related slowdown.

The UK three months rolling GDP increased by 0.3% in May in the first reading ever made by the Office for National Statistics (ONS). The UK GDP growth was driven by services, with falls in construction and production.

The UK services marked 0.4% m/m growth in the services industries in the three months to May and had the biggest contribution to GDP growth. However, contraction in the production and construction industries meant that they each had negative contributions to GDP.

At the same time, the UK manufacturing output rose 0.4% over the month in May, falling short of 0.9% increase expected by the market. The broader index of industrial production combining the performance of manufacturing, mining, and energy supply sectors fell -0.4% m/m.

Breakdown of the UK monthly GDP

Next week will be packed with the most important UK macro indicators including inflation, UK labor market data, and the UK retail sales. While the UK unemployment is expected to remain at four decades low of 4.2%, the UK wages are expected to decelerate to 2.7% y/y in May. On the other hand, the main monetary policy indicator, the UK inflation, is set to pick up with the headline inflation expected to rise 2.6% in June while core inflation stripping the consumer basket off food and energy prices are projected to increase by 2.2% over the year. Finally, the core UK retail sales are anticipated to increase by 0.3% over the month in June, completing the UK macro picture before the August 2 Inflation Report from the Bank of England that is expected to see the Bank rate hiked by 0.25%.

The Bank of England Deputy Governor Jon Cunliffe confirmed the official Monetary Policy Committee’s (MPC) stance on the growth outlook saying that significant drop in activity in the UK in the first quarter of this year looks to have been largely an aberration, driven by poor weather. The overall picture is of the UK economy expanding around or a little above its potential rate of growth. Cunliffe suggested that MPC’s growth forecast from May Inflation Report are likely to remain unchanged in August. Cunliffe also said that the llatest wage data do not signal strongly that pay growth will make the next step to establish itself firmly in 3% territory as indicated in May’s Inflation Report forecast.

While the UK fundamentals are seen supporting the Bank of England rate hike expectations that support Sterling, the technical picture for the GBP/USD turned bearish with currency pair attempting to break 1.3100 level to the downside.  Technical oscillators on the daily chart turned lower with Slow Stochastics indicating further downside potential. The GBP/USD is now expected to attack 1.3100 representing 38.2% Fibonacci retracement of a post-Brexit slump from 1.5020 to 1.1940 now with breaks below targeting 1.3050 and 1.3000 psychological level. 

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Technical analysis

GBP/USD daily chart

The daily chart saw GBP/USD rebounding decisively above 1.3300 with the corrective move peaking at 1.3360. The combination of Brexit and politics related news weighed on Sterling that fell lower over the second week of July with the technical oscillators like Momentum and the  Relative Strength Index turning lower on the daily chart.  The GDP/USD was unable to cross substantially below 1.3100 on Friday and retreated to mid-1.3100 territory. Breaking 1.3100 level representing 38.2% Fibonacci retracement level of the post-Brexit fall represents a near-term target for GBPUSD with breaks below psychologically important 1.3000 level opens the way to 1.2670, representing 26.3% Fibonacci retracement of a post-Brexit slump.

GBP/USD 1-hour chart

With the spot rate leaping up to 1.3200 from 1.3100last Friday’s lows, the technical picture on GBP/USD on the 1-hour chart is turning bullish. The currency pair broke away from the upward sloping channel, but the technical oscillators already turned higher with Slow Stochastics rising up towards the overbought territory and both Momentum and the Relative Strength Index rising higher. With break above 1.3200 GBP/USD is seen testing 1.3280 and the round big figure of 1.3300-1.3350 as next hurdle representing swing high and the upper boundary of the upward rising channel trendline. 

Economic fundamentals in the week ahead

The UK macro calendar for the third week of July includes all the most important figures before the Bank of England’s August Inflation Report scheduled for Aust 2, 2018.

The first data on the agenda is the UK labor market report that is likely to see the claimant count fall by 26.5K in June, after falling -7.7K in May with the unemployment rate remaining steady at four decades low of 4.2%. The all-important wage growth data might be disappointing with the average weekly earnings excluding bonuses expected to decelerate to 2.6% over the year in three months to May compared to 2.7% y/y in the previous months.

The UK inflation though is expected to pick up slightly in June with the headline inflation expected to accelerate to 2.6% in June while core inflation is seen rising 2.2% over the year.

The UK retail sales report is due on Thursday with total sales expected to rise 0.5% over the month in June while core retail sales excluding motor fuels sales are seen rising 0.3% m/m.

UK economic calendar for July 16-20

On the other side of the Atlantic, Monday's retail sales report in the US headlines with the market expectations of 0.6% m/m increase in June while core retail sales are seen up 0.4% m/m.

The most important economic event in the US is Federal Reserve’s chairman Jerome Powell ’s testimony in Congress that is due on Tuesday and Wednesday next week.

US economic calendar for July 16-20

Forecast for the next week

The FXStreet Forecast Poll for this week was almost perfect with the spot rate at the time of finishing this report around 1.3200 while the forecasters turned bearish estimating GBP/USD at 1.3229 by the end of next week.

While bullish versus bearish predictions distributed 40% vs 50% among forecasters participating at the FXStreet Forecast Poll last week, the current forecast for the third week of July expects spot rate to fall to 1.3135 compared with only 18% of bullish versus 68% of bearish predictions for the week ahead.  

This compared to an overly bullish forecast two weeks ago with 69% of forecasters expecting the bullish trend in one week time compared to 65% of participants in the FXStreet Forecast Poll turning GBP/USD bearish three weeks ago. 

As long as longer-term forecasts are concerned, the FXStreet Forecast Poll stood firm expecting GBP/USD to reach 1.3218 in one month time from now compared to 1.3258 last week and compared to 1.3237 two weeks ago. Same stability of predictions is seen in three months time from now, with FXStreet Forecast Poll forecasting GBP/USD at 1.3245 in three months time from now compared to 1.3249 last week and 1.3244 predicted two weeks ago. 

FXStreet Forecast Poll

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