Pound gains ground on broad USD retreat

The British pound is finally in positive territory, after a nasty slide over most of the past week. In the North American session, GBP/USD is trading at 1.3145, up 0.39% on the day.

On Thursday, the UK releases Final GDP for the fourth quarter, which is expected to confirm the initial reading of 1.0%. This would be a modest but respectable gain, but there are ominous clouds on the horizon for the UK economy. The Office for Budget Responsibility (OBR) has sliced its growth forecast for 2022 from 6% to 3.8%.

Bailey warns of shock to UK incomes

Earlier in the week, BoE Governor Bailey warned that soaring energy prices would trigger a “historic shock to real incomes”, which would dampen economic growth and consumer demand. Inflation hit a 30-year high of 6.2% in February and the BoE says things could get worse, as the Ukraine war could push inflation as high as 8% in Q2 and even higher in the third quarter.

Bailey & Co. are clearly worried by stagflation, in which inflation accelerates even as growth declines. The last time the UK experienced significant stagflation was in the 1970s, as OPEC imposed an oil embargo on the UK and other Western nations. Bailey noted that the shock from energy prices this year would be worse than any single year in the 1970s and that the challenge the BoE was facing was immense.

The BoE can, of course, ratchet up interest rates to contain inflation, but the danger is that inflation should ease without rate hikes if the economy is weakening, in which case higher rates would do more damage than good. Governor Bailey will have to chart out a rate-tightening cycle in which interest rates are high enough to lower inflation but don’t choke off growth. Time will tell if the Bank will “get it right” with the pace and size of upcoming rate hikes.

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GBP/USD Technical

• GBP/USD faces resistance at 1.3259 and 1.3341
• There is support at 1.3130 and 1.3048

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