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In a strong economy, high inflation prevails, while in a weak one, inflation tends to be low. These fundamental principles of economic theory remain unchallenged. Hence, a valid question emerges: Where did the pound surge to at the onset of the year amidst a recession in Britain? British inflation stands far less chance of accelerating compared to its American counterpart, implying that the Bank of England might initiate rate cuts before the Federal Reserve. It wasn't until spring that investors confronted reality, enabling them to sell GBP/USD without hesitation.
In the fourth quarter, UK GDP contracted by 0.3% after a 0.1% decrease in the third, which is commonly referred to as a technical recession. Throughout 2023, gross domestic product decreased by 1.2%, which is incomparable to the expansion of its American counterpart by 3%. Britain is the only G7 country to face a decline, so the sterling's leadership positions at the start of 2024 should cause bewilderment.
Dynamics of the British economy
In reality, the core issue lies in the higher inflation rates compared to other developed countries, particularly in the USA and the Eurozone. Investors believed that the Bank of England would hold rates longer than the Federal Reserve and that the European Central Bank (ECB) would lower them less than the central banks' main competitors. Convergence in monetary policy allowed the "bulls" to boost GBP/USD quotes to 7-month highs in early March. But it wasn't enough for more.
The pound plummeted as consumer prices slowed to 3.4% and inflation expectations dropped from 3.6% to 3.3% over a 12-month horizon. In the Forex market, there is much talk that UK inflation could quickly return to the 2% target. The BoE predicts this will happen in the second quarter, which is worse for GBP/USD. Derivatives suggest that London will begin to loosen monetary policy in June or August and take three steps towards monetary expansion in 2024.
Inflation dynamics in Britain
This is comparable to forecasts for the federal funds rate. The futures market signals a cut in June with a 67% probability. Its focus is on the option of borrowing costs falling by 75 basis points this year. Furthermore, if American inflation continues to accelerate in March, the Federal Reserve may postpone the start date of monetary expansion to a later date, which will negatively affect GBP/USD.
Clues can be provided by statistics on the American labor market. According to Bloomberg experts, non-farm payrolls in March will increase above the 200,000 mark for the fourth consecutive month, while unemployment will remain at the same level of 3.9%. Despite the slowdown in wages, their growth rates are still very high – 4.1%. The labor market is as strong as a bull, and so is the U.S. dollar.
Technically, on the daily chart of GBP/USD, the implementation of the Broadening Wedge pattern continues. Short-term consolidation of the pair may end with an upward breakout, however, a rebound from resistance at the pivot level of 1.269 will be an excellent opportunity to increase short positions formed from 1.275.
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