Cable's On a Roll - GBP/USD Could be Over 1.6500 by Christmas

Cable's on a roll. The UK economy is improving, consumer and business confidence are rising and crucially so is the all important real estate market. That rosy picture is likely to be reinforced going into Christmas – traditionally a good time for GBP.  

Conditions are now ideal for GBP/USD to clear tough overhead resistance levels between 1.6300-1.6500. The 4-6 weeks leading up to the New Year are generally favourable for risk assets and currencies. For stocks it's the setting for the so called Santa rallies and what's good for risk assets is usually good for risk currencies such as GBP.

But add in that the UK economy is looking its best in five years – there's good reason to believe that the next  five weeks should be good for GBP. Consider that UK services firms, which dominate the economy, are hiring at their fastest pace in six years, according to the country's largest business lobby, the Confederation of British Industry.  

UK unemployment currently sits at around 7.6% and may now fall rapidly towards 7%, the threshold where the Bank of England may start reconsidering its ultra-lose monetary policy. Apart from employment figures, the other key numbers to watch are those concerning inflation.

Any significant pick-up in inflationary pressures may well prompt the Bank of England to reconsider its dovish stance on monetary policy. Admittedly, a strong GBP will do much to mute inflationary pressures. But an increasingly robust economy and rapidly rising real estate prices in the south-east of the country could see the central bank tightening interest rates sometime during H2 2014, which would be dynamite for GBP potentially powering it all the way up to 1.7000 versus USD. 

Santa rally on the cards for cable?

Now for some caveats

But of course any forecast comes loaded with caveats given the currently highly uncertain global economic climate. A strong showing from the US economy may bring forward expectations that the US Federal Reserve may seek to aggressively taper its quantitative easing programme, possibly before March 2014. That would be bullish for USD. 

Then around January/February it's the re-run of the US debt ceiling negotiations. It's a spectacle markets are getting used to and they expect positive resolutions. Nonetheless, they do inject an element of uncertainty, which isn't necessarily good for risk currencies such as GBP.

Another source of global uncertainty are EU parliamentary elections in February, which could see a strong rise in anti-EU political parties. Probably around mid-2014 the European Central Bank will publish the results of stress tests on the financial health of Eurozone banks. The run-up to both events could cause some uncertainty in the markets.

However, should H1 2014 prove to be relatively benign or even positive for the global economy, GBP/USD could well reach 1.7000.

A quick reality check

A major drag on sustained GBP strength is the UK current account deficit forecast by the European Commissionto hit 4.3% in 2013, 4.4% in 2014,  compared with 3.8% in 2012.  Also, current growth appears to be fuelled in part by a decline in the household savings rate. This is fine in the short term, but unless alternative growth drivers kick in, growth will not be sustainable.   

Then there's the Bank of England's attitude towards a strengthening currency. They may not like it.

And strong currencies are hardly fashionable these days among policy makers.

By Justin Pugsley, Markets Analyst MahiFX

twitter: @MahiFX

Disclaimer: This material is for general information purposes and does not contain, and should not be construed as containing, investment advice or an investment recommendation, or an offer of or solicitation for any transactions in financial instruments. MahiFX makes no representation and assumes no liability as to the accuracy or completeness of the information provided.