Ahead of the February Bank of England meeting, the pound is demonstrating increased strength against the dollar, marking its third consecutive day of gains. Previously, the GBP/USD pair was trading within the 1.22 range, but it is now approaching the resistance level of 1.2550, indicated by the upper line of the Bollinger Bands on the daily (D1) timeframe.
It's important to highlight that this upward price movement is primarily driven by a weakening of the US dollar. The US dollar index has been declining for three consecutive days and is nearing the 106 mark. However, the pound does not appear as strong in cross pairs; for instance, the GBP/JPY cross is experiencing a significant decline on Wednesday. What does this indicate? Primarily, it suggests that the current increase in the pound-dollar pair should be approached with caution, especially considering the underlying reasons for the dollar's weakness, which will be discussed further below.
It is important to note that following the BoE's meeting in February, the pound could face significant pressure, which may hinder GBP/USD buyers from driving the pair higher. In other words, the current situation with the pair is uncertain, and the upward prospects could turn out to be misleading.
The majority of analysts anticipate that the BoE will cut the interest rate by 25 basis points on Thursday, reducing it to 4.50%. This widely expected decision has already been factored into the market since mid-January, following the release of the latest UK inflation data.
To briefly recap, the overall Consumer Price Index (CPI) in the UK rose by 2.5% year-on-year. For two consecutive months, the figure showed an upward trend (reaching 2.6% in November), but in December, it unexpectedly slowed, contrary to forecasts (most experts predicted the index would remain at November's level). The core CPI also entered the "red zone." Instead of the expected slowdown to 3.4% y/y, it decelerated to 3.2%. After two months of growth (October, November), the indicator fell more sharply than anticipated. The Retail Price Index (RPI), which is used by employers during wage discussions, also slowed slightly. On an annual basis, RPI decreased to 3.5%, compared to the expected growth to 3.8%. Meanwhile, CPI inflation in the services sector dropped sharply in December to 4.4% y/y, marking the lowest level since March 2022.
Following the latest release, the GBP/USD pair began to lose ground, reflecting the anticipated rate cut in February. The price dropped nearly 500 pips, reaching a 14-year low of 1.2099. However, the pair then reversed direction and moved higher due to a general weakening of the U.S. dollar.
Why is the greenback weakening? The main factor is the expectations of a potential deal between Trump and Xi Jinping. Trump imposed a 10% tariff on all Chinese goods, prompting China to retaliate with tariffs on various American products. Additionally, Beijing restricted the export of several metals used in U.S. energy, defense, and other industries.
The market quickly recovered from this "exchange of blows." For instance, GBP/USD sharply declined to 1.2248 on Monday but rebounded by 300 pips within three days, with Wednesday's high reaching 1.2550. Traders are hopeful that the U.S.-China trade war will conclude similarly to the tariff conflicts with Canada and Mexico.
Are these expectations justified? On one hand, negotiations between the parties are clearly ongoing. On the other hand, White House representatives, including Trump, have announced twice that a conversation with Xi Jinping would take place. However, these announcements never materialized, indicating that negotiators have not yet reached a compromise. If the situation remains unresolved in the near term, anti-risk sentiments may resurface in the market, leading to increased demand for the dollar. Given the fragile state of the British currency, it is unlikely that the pound will be able to sustain upward movement on its own.
Following the results of the February meeting of the BoE, the British pound may become a key factor for the GBP/USD pair if the central bank announces the next steps to ease monetary policy.
Even a split vote within the Monetary Policy Committee (MPC) could trigger volatility. A 0-8-1 result is expected—zero votes for a rate hike, eight for a rate cut, and one vote (Catherine Mann) to maintain the rate at 4.75%. If even Mann, the most vocal hawk, supports a rate cut, the pound will come under intense pressure.
The central bank may pay close attention to the January data on the business activity index (PMI) in the UK, which has been revised downwards for both the services sector and overall activity. Although the indicators still remain in the expansion zone, they are nearing the threshold for contraction, with readings of 50.8 and 50.6.
Adding to this is the sluggish growth of the British economy. According to the latest data, UK GDP increased by just 0.1% in November (compared to a forecast of 0.2%).
The BoE is likely to take a dovish stance at its February meeting, emphasizing slowing inflation, weak economic growth, and declining business activity. In this context, the potential for further growth in GBP/USD will largely depend on the overall market interest in risk assets, particularly regarding developments with Trump and Xi Jinping.
Given this uncertainty, making any trading decisions at this moment seems risky. Both selling and, especially, buying GBP/USD appear unwise, despite the recent price increase.
