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Neil Davies, Head of Trading, PlutusFX, comments on the week’s currency prospects

Since the near miss of 1.70 on 6th May and subsequent retracement to 1.67, GBP/USD has on two days this week breached the mark and is again toying with it today, as I write standing at 1.7021

 

After last week’s indication of a nearer term rate rise in the UK, we have seen UK CPI drop to only 1.5%, well under the Bank of England’s 2% target, with some commentators quick to report that the Governor might have spoken too soon with regard to a rate increase. I would however suggest that inflation may not remain low for too long. The world economy has benefitted of late from several years of benign oil prices. We would have all noticed and taken for granted that prices at the pumps have remained steady and resigned the protests by truckers to history. This is now changing. Oil prices have this month moved back up to the region of the last peak in 2011. Unless there is a retracement, this will feed into prices and prompt the UK rate increase.

On the US side of the pair we have seen growth forecasts cut by the Federal Reserve for 2014 down to 2.1-2.3% from the 3% previously predicted. The Central Bank bond buying program has continued to be cut as expected and the indication is that rates will remain unchanged beyond the end of the stimulus program. Janet Yellen expects inflation to remain below 2% to the end of 2016. The US has a huge advantage over the UK with regard to energy cost. Massive Shale Gas production has allowed homeland energy prices to decrease, thus making the US economy as a whole much less susceptible to outside price increases.

So what does all this mean for Cable? Interest rates in the UK are likely to start rising around a year before they do in the States. This will increase the demand for Sterling. How much of this is already priced into the rate of 1.70 only time will tell as there has already been a one way Cable rally for nearly a year, but a return to an increasingly strong dollar is unlikely within a framework of divergent interest rate policy.

 

Neil Davies, Head of Trading, PlutusFX

 

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