British Pound to Dollar Rate Stuck on the German DAX, Still Eyeing Test of 1.40

Inflation data out of both the UK and US will dominate the economic agenda in the week ahead while chartists will be watching for a break lower beyond 1.40 in GBP/USD.

Pound to dollar exchange rate outlook

The British pound has rallied sharply at the start of the new week amidst a spurt of broad-based sterling buying.

We note that the move can largely be explained by moves on the German DAX which is in turn being driven by risk sentiment.

German DAX

GBP to USD

Funny that the German stock market is more of a predictor of the pound's fortunes than is the domestic FTSE 100.

But this is understandable when you consider that the the interplay between the dollar and the pound is also a function of the interplay between the euro and the dollar; demand for dollars against the euro can often be reflected in demand for the dollar against sterling.

It would be unwise to get bogged down in the dynamics of this interplay; what currency watchers should note is that the relationship between the DAX and GBP/USD is relevant this month, and this is in turn influenced by risk.

Importantly, risk that drives the FTSE 100 is different to risk that drives the DAX as the former is a market heavily reliant on commodity stocks. Of course this relationship could break down at any time, but for now at least, watch the two markets for clues.

1.40 Pivot to be Tested

Turning to the outlook, it is hard to get excited about sterling's prospects.

The GBP/USD exchange rate came under pressure once more last week and broke below a key trend-line connecting the January and March lows, which has seen us cancel our formerly positive short-term stance.

Our eyes are however firmly fixed to the psychologically significant 1.4000 handle where the S1 monthly pivot is situated.

Monthly pivots tend to present obstacles to prices as they attract buy orders en masse from traders expecting a bounce or reversal at the level of the pivot.

As such, a clear break below the S1 would be required to forecast more downside.

Such a break would be confirmed by a move below 1.3960, with a target at the 1.3835, February 29, 7-year lows.

Outlook for the GBP to USD exchange rate

Cameron Scandal to impact on Bremain?

Turning to the fundamental outlook it would seem political considerations are outweighing economic ones.

As the 'Bremain’s' figurehead, there is a risk that the scandal affecting David Cameron over money he secretly held in an offshore account in Panama, may also taint the pro-EU vote, tilting the advantage back towards Brexit in the upcoming EU referendum.

Markets are currently not pricing an exit as a possibility, but if there is evidence from future polls that the scandal has damaged the Bremain campaign, it could signal the onset of another leg lower in GBP/USD.  

More Brexit-Inspired Selling Expected

GBP/USD has lost about 8.0% of its value solely as a result of fears the UK will leave the EU, according to research by Italian bank UniCredit who have sought to quantify the impact of Brexit on the UK currency.

This is still a relatively small depreciation given the potential turmoil resulting from a referendum vote to leave, and in comparison with the losses suffered by the pound in the Scottish independence referendum and the previous general election, argue analysts at Dutch Bank ING:

“Looking back at how much risk was priced into GBP ahead of the 2014 Scottish referendum, and then the 2015 UK general election, we feel that a larger risk premium is required in GBP crosses now.”

This indicates further losses are likely for the pound as the full extent of Brexit risk is absorbed.

An expected seasonal uplift for sterling in April could help stem losses over coming weeks, according to the view of analysts at Bank of America Merill Lynch, who see a delay in further downside until the seasonal effect dissipates, in May.

Dollar Down

The dollar fell after Fed Chairman Janet Yellen took a cautious line in a speech to the Economic Club of New York which indicated that she was not yet ready to raise interest rates.

Interest rates stimulate demand for a currency from international investors seeking higher rates of return, so any delay in raising them impacts negatively.

The publication of the minutes of the March FOMC drew attention to the potentially negative impact of global factors on the US economy further weakening the dollar.

Data Hot-Spots in the Week Ahead

The major releases for the pound in the week ahead are the Bank of England (BOE) April Rate meeting on Thursday April 14 and March inflation data on Tuesday April 12.

Markets have side-lined the question of when the Bank of England (BoE) will raise interest rates until after the referendum has past, so neither the CPI on Tuesday or Thursday’s BOE meeting are likely to cause much volatility.

US Annualized CPI is released on Thursday April 14, and is expected to remain unchanged at 1.0% in March. It has been trending higher recently and if it shows an above-expectations rise that could increase the possibility that the Federal Reserve will raise interest rates again.

The Fed Funds Rate is currently between 0.50 and 0.75%, but some analysts believe it could probably rise by a further 0.25% in 2016.

US inflation data

Data from China on the same day, showing preliminary estimates for Chinese first quarter GDP, could also have a massive impact on the markets, with the potential for a negative result causing a down-turn in global risk appetite.

Reports that Chinese bonds have suffered record losses on Friday April 8 do not bode well for the outlook as stocks often follow bonds, and a further steep sell-off in Chinese equities could reinforce risk aversion, leading to a fall in the dollar.

The FOMC minutes underscored the importance of outside, global factors on the US economy and a low GDP result in China, would only harden those concerns, limiting the chances of a further increase in interest rates and therefore upside for the dollar.