The Bank of England is at a crossroads. The UK economy is strong, and inflation is up to 2.5%. However, an early start of monetary normalization can result in unwanted consequences. Let us discuss the Forex outlook and make up a trading plan GBPUSD.

Weekly pound fundamental forecast

While the US dollar is trading flat ahead of the US jobs report, the British pound is rising ahead of the BoE meeting. Andrew Bailey and his fellow central bankers could provide a number of surprises, which should not be dovish. This fact lures investors to the sterling.

The BoE has 1.9 million reasons not to rush to normalize monetary policy and stick to the same stance as the Fed. 1.9 million is the number of British people who have lost their jobs due to the pandemic and still cannot find work. The recovery of the labor market is a necessary condition to start tightening monetary policy. The majority of MPC members are ready to adhere to an accommodative policy not to interrupt the economic recovery. According to the IMF, the UK economy will grow faster in 2021 than in any other G7 country, which is not surprising against the background of successful vaccinations and lifting of the lockdown. Currently, 57.6% of UK citizens have received both doses of the vaccine. According to this indicator, the UK among the large is third after Canada (59.7%) and Spain (57.9%) among the large developed countries.

It might be too early to withdraw the stimulus, but the BoE should be prepared to do it correctly. In 2018, the BoE set a threshold for the Bank rate of 1.5%, upon reaching which it will start unwinding the QE and stop reinvesting the proceeds of maturing gilts in new purchases. At that time, the five-year gilt yields were at 1.2%; now, they are around 0.3%. Therefore, markets do not expect BoE rates to reach 1.5% any time soon. Analysts expect a new lower bound for the Bank Rate of 0.5% – 0.75%. If the BoE scraps the threshold entirely, it will start reversing QE before it raises rates. It is the first good news for the GBPUSD bulls.

QE Dynamics of UK QE

     

Source: Bloomberg.

In my opinion, such a decision will look logical. If the BoE continues to acquire assets at the same pace as before, the share of securities on the central bank’s balance sheet will exceed 50% of their total value, compared with 33.6% of the Fed. This is an amount equivalent to almost 40% of the UK GDP, compared with 20% before the pandemic. I suppose as early as in August, at least 2 out of 8 MPC members can vote for the start of QE tapering. If there are two hawks, it will be the second surprise for the sterling bulls from the Bank of England.

Finally, the third pleasant surprise may be an increase in inflation forecasts. The UK inflation reached a three-year high of 2.5% in June and is likely to continue rising until the end of 2021. BoE can well raise its CPI projections at the end of the year from the current 3% to 3.5%, which implies a 2% rise in consumer prices in 2022-2023 and can be interpreted as a signal of an earlier Bank rate hike than is currently expected by the market.

Dynamic of UK inflation

Source: Bloomberg

Weekly GBPUSD trading plan

Therefore, the BoE can give three pleasant surprises to the pound buyers, but it may not do it. The GBPUSD rally on the news could be followed by a sell-off on the fact. It will be relevant to sell if the pound doesn’t break out level 1.3955 or updates the local high.

   

 

Price chart of GBPUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official…



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