The US dollar index continues to recover, reaching new three-week highs near 102.40. This is due to the lack of significant changes in the overall market risk sentiment, supporting an optimistic session.
Currently, investors and the forex market have shifted into a wait-and-see mode, anticipating important releases, especially the US labor market report, which may influence the Fed's future actions.
Pay attention to US data such as the final S&P Global Manufacturing PMI, construction spending, and ISM Manufacturing PMI for July.
The dollar also gained from risk aversion after the ECB's decision, but it may face obstacles due to the Fed's data-dependent stance and cooling labor market and disinflation concerns.
Analysts believe that assumptions that the last rate hike in July might be the last in the current cycle could exert some pressure on the dollar.
On the traders' agenda, concerns related to the US economy persist, including debates about a soft or hard landing. The focus remains on questions about the terminal interest rate and geopolitical tensions with Russia and China, including the US-China trade conflict.
Currently, the US dollar index is targeting 102.55, and then 103.54 and 103.69. In case of a decline, possible support levels are at 100.55, 100.00, and 99.57.
Pound and politics
This week, special attention will be given to the British pound due to the Bank of England's meeting. Another event traders are looking at regarding the pound.
Improving political prospects in the UK mean that the pound may see growth against the US dollar and stable trading against the euro in the coming months and years.
As noted by Berenberg Bank, the major political parties in the UK are no longer led by populists. Meanwhile, improved relations with the EU and significantly reduced chances of a Scottish independence referendum will allow the pound to be guided by fundamental factors again.
Apparently, the British pound lost attractiveness among investors after the UK's decision to leave the EU. From November 2015 to November 2016, the pound fell by 19% against the dollar and by 21% against the euro. However, now, after some time has passed, the UK is advantageously distinct from its counterparts.
The pound faced difficulties in the years following the Brexit vote due to chronic political uncertainty, with changes in prime ministers, and even signing the Brexit agreement did not put an end to the uncertainty.
Negotiations with the EU on Northern Ireland concluded only this year, restraining any pound recovery.
However, pessimism reached its peak in September 2022 with Prime Minister Liz Truss's mini-budget, which triggered significant sell-offs in gold and the pound, as investors worried that the UK's financial prospects would deteriorate significantly.
However, this turned out to be a turning point as lessons from the experiment with populism led to a return to orthodoxy under the current leader Rishi Sunak.
Meanwhile, the Labour Party, potentially coming to power in 2024, also underwent a change: the extremely left-wing Jeremy Corbyn was replaced by centrist Keir Starmer.
All that happened is crucial for the currency markets, which are highly sensitive to uncertainty and have allowed the pound to slowly reduce its political risk premium in recent months.
Potential risks from extreme left or extreme right forces, as well as the risk of Scotland exiting the UK, have significantly diminished.
The potential improvement in the UK's political situation may serve as a basis for markets to return to a more fundamentally-driven approach to pricing the pound, with less emphasis on political risks.
Currently, the pound is contending for the title of the most effective major currency in 2023, alongside the Swiss franc.
The pound-to-euro exchange rate has risen by 3% since the beginning of the year, and the pound-to-dollar exchange rate has increased by 6.2%.
An improved political background doesn't automatically mean that the pound will strengthen against all currencies.
The improvement in the political background suggests that the UK's relative economic indicators, inflation prospects, and the Bank of England's policy should once again become the dominant driving force of pound trends.
Three growth factors
Against the dollar, a gradual strengthening of the pound to 1.4700 from the current 1.2900 is expected, representing an increase of about 14%.
There are two reasons for this. Firstly, the weakening of the dollar as markets shift to higher risk during 2024 and 2025 due to the improvement in the global economy.
Secondly, note the narrowing growth gap between the US and the UK due to the less sluggish performance of the UK now that the political situation is improving.
Thirdly, pay attention to the somewhat less impressive growth in the US as the strong fiscal tailwind of recent years becomes more moderate.
The aspect of valuation plays a role. While the pound traded toward the lower end of its range since 2008 against the dollar, against the euro, it remains within its range since 2008.
The pound's growth from 2013 to 2015 was largely driven by the economic weakness of the eurozone after the euro crisis. Since the eurozone is no longer suffering from a severe crisis, the peak of 2015 for the pound is not a useful benchmark.
Therefore, it is expected that the pound may moderately rise against the euro this year, with the GDP of the UK and the eurozone growing at similar rates.
British pound now
Regarding the short-term prospects of the pound, it remains vulnerable ahead of the Bank of England's monetary policy meeting.
The Bank of England is expected to make a 25 bps interest rate hike on Thursday. This hawkish move will help maintain pound confidence and may lead to further strengthening to 1.3000.
Additionally, the pound is supported by the rise in UK bond yields compared to US bond yields, which contributes to its strengthening.
On fresh charts, the British currency shows a steady decline from 1.2800, but support at the 1.2760 level may prevent further losses.
