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The British pound has managed to quickly recover lost ground and continues to contend with the U.S. dollar for the title of the best performer among G10 currencies this year. Bulls for GBP/USD are looking optimistically at the upcoming budget proposal by Chancellor Jeremy Hunt. It is expected to include fiscal stimulus that could accelerate the GDP of the United Kingdom and positively impact the sterling.
Life consists of ups and downs. The first half of 2023 saw the pound leave behind challenging times when the British economy entered a recession. Its gradual recovery could accelerate with extensive fiscal stimulus, including tax cuts and increased government spending. Simultaneously, this would be excellent news for GBP/USD, as such policies are pro-inflationary. It would increase the risks of reaching a new peak in the Consumer Price Index (CPI) and shift the timing of the Bank of England's monetary expansion from summer to September.
The new stimulus will be beneficial not only for the economy but also for stocks. As a result, U.K. stock indices, which have been trailing their counterparts, will make up for lost ground. Capital inflows into Britain will provide support for GBP/USD.
Dynamics of stock indices
Regarding the Treasury, there is a risk of overdoing it – presenting stimulus that may appear overly aggressive to the markets. This could lead to panic, similar to the end of 2022 when former Prime Minister Liz Truss's government announcement of a mini-budget cost her the prime minister's post, and the pound plummeted almost to parity with the U.S. dollar.
I don't believe that fears of a repetition of that story should be relevant in 2024. Back then, the Bank of England tightened monetary policy, and the easing of tax and budget policy was viewed by investors as a contradiction and a political mistake. Now, the BoE is ready to embark on the path of monetary expansion. Synchronizing it with fiscal policy in the face of a weak economy is the right decision. Therefore, the more stimulus the Treasury provides, the better for GBP/USD.
Their pro-inflationary nature will support the pound, thanks to the rise in yields of British bonds. Deutsche Bank forecasts that their issuance will increase from £237 billion in the 2023/2024 fiscal year to £271 billion in 2024/2025. This will keep UK debt market rates high while they decline in other countries. Divergence will play into the hands of GBP/USD.
Speed of quantitative tightening programs
Moreover, due to losses, the Bank of England is forced to shrink its balance faster than its counterparts at the Federal Reserve and the ECB. According to the regulator's calculations, its size could be around £100 billion over the entire duration of the quantitative tightening program.
Technically, on the daily chart, GBP/USD has an inverted Splash and Shelf pattern based on the 1-2-3 formation. A breakthrough of the upper boundary of the consolidation range 1.261–1.269 or the Shelf will be a reason to increase long positions formed earlier from the level of 1.2635.
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