Macro fundamentals and the subsequent expectations of the future paths of monetary policy of both the Fed and BoE is expected to dictate movement on the GBP/USD pair in the second half of this year.
As broadly expected, the 2014 correction optimism on the US Dollar has been cooled markedly by a set of disappointing first-quarter growth data.
On the other hand, in the UK the Bank of England's (BoE) data-driven monetary policy has boosted the pound by over 3% in the first half of the year, led mostly by market consensus favouring sooner monetary policy tightening in the Old Continent rather than in the US.
Sterling ended the first half of 2014 at its highest level since 2008 against the US currency, despite both countries using an expansionary monetary approach to recovery.
For now, it appears the focus has moved to the competition over the first benchmark rate increase. The markets have also increased sensitivity to any fresh hints from policymakers on both sides of the Atlantic. Those hints are being strongly influenced by fresh macro data, at least in case of the BoE.
What can we expect from the currency pair in the second half of this year? And who will be the winner of the rate-hike challenge? The tightening competition scales seems to be tipping in favor of the BoE for now, reflected by stronger-than-expected macro fundamentals which have been successfully supporting sterling so far.
Dollar misses helping hand
Following the first-quarter growth disappointment, the US currency was unable to hold the line on all of its fronts, closing the first half of the year in poor conditions.
Back in March, Fed Chairman Janet Yellen's hawkish, and awkward, comments on the time-frame of the first rate hike, hinted a longer-term bullish trend for the dollar. However, following the release of the April Federal Open Market Committee (FOMC) minutes, the trend swiftly switched direction.
A significant contraction in first-quarter US growth, albeit being strongly connected to inventories changes, had further hurt the US currency to such an extent that any marginal indicators have not been able to reverse the downward path so far.
Rate-hike speculations have for now shifted the markets' bets to the second half of 2015, later than previously expected (from March, following the FOMC statement), thus leaving the battlefield for dollar counterparts.
As for the labor market, the statistical improvement has been seen on the unemployment rate, with economic projections seeing the gauge realistically reaching desired levels during 2014. But the previous moves on the dollar, following releases such as the non-farm payrolls data, seem to have faded away after numerical data on joblessness has been dropped out of the statement due to its pleasant development.
As for the QE, the previous year's quantitative easing tapering issue was solved in December, after Fed set it up on an 'autopilot', by reducing the asset-purchases by $10 billion per meeting, therefore with no bullish incentives for the market.
Overall, due to its fundamental background, the US dollar tends to seek any remarkable support from the central bank which, at least for now, the Fed's 'later-preferred-rate-hike' sentiment fails to offer.
Data-driven sterling
Despite the increased volatility caused by mixed messages from the BoE's top officials, sterling keeps its upward path primarily on the back of stronger-than-expected macro data.
Solid growth in the first quarter is expected to be followed by even stronger output in the following quarter. The latest business survey by Markit on the UK manufacturing sector clearly showed the economy keeps its momentum in the second quarter.
In its latest Monetary Policy Committee (MPC) minutes, the policymakers said growth in the second half of this year should maintain its pace and slack would be absorbed more quickly than had been previously predicted. In such case, there would be an increased probability the first rate hike may come before the end of this year.
However, the June MPC minutes revealed that "analysis of options prices suggested that market participants put only around a 15% chance on a rise in Bank Rate by the end of 2014," which the BoE said was surprising given the strong macro data coming in. In BoE Governor Mark Carney's words, his sudden hawkish Mansion House speech was aimed at correcting the markets.
Technical analysis
As for the GBP/USD currency pair, we have seen likeable conditions for the British pound since October 2013 after sterling firmly left the $1.5 level on the back of the US government shutdown. The UK currency's upward movement, apart from only minor corrections, has since been supported by the above-mentioned UK fundamentals.
Now trading at a five-and-a-half-year high, near a resistance level from the 1990s, we may expect a continuing bullish bias to even touch $1.735 until a correction potentially down to the 50% Fibonacci retracement level.
On the other side, from the short-term perspective, the $1.69 level also seems realistic in the event of an unexpectedly negative series of data coming in between now and 2014 end. In addition, Carney's swift about turn on his dovish stance could also fuel some slightly bearish tendencies as well.
From a long-term perspective, we may expect central-bank-challenge-driven progress on the currency pair. The faster the British economy takes its steps towards a first rate-hike, the more the British currency gains over the trudging dollar. With weak summer trading and low volatility, the trend looks set to continue until the Fed's projections are revealed in September.
If no relevant bullish outcome is revealed at the FOMC meeting in September, and the BoE will stay on track with its data-driven policy, we may even expect sterling to reach the $1.78 level this year. But only if the macro data flow continues to surprise on the upside.
However, the BoE has already expressed concerns about the strength of pound as it may hurt exporters. Also, the UK current account deficit was in the first quarter the second largest on record and the UK trade balance persistently generate deficits.