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In: Finance, Forex

After sinking to a multi-year low near 1.2415 last week, GPB/USD has stabilized, bounced modestly and started to consolidate around the psychological 1.2500 level. Although the relentless sell-off and sharp moves have moderated somewhat, volatility could pick up in the coming days, with two key risk events on the calendar: the FOMC rate announcement on Wednesday and the Bank of England’s monetary policy decision on Thursday.

The Federal Reserve will announce its May monetary policy decision on Wednesday night. There is broad consensus on Wall Street that the central bank will raise its benchmark interest rate by 50 basis points to 0.75-1.00% to tame soaring inflationary pressures.

This would represent the second adjustment during the current tightening cycle, but the first non-standard 25 basis point hike since early 2000.

Policymakers are also expected to formally announce a plan to begin quantitative tightening, in line with the parameters set out in the March FOMC minutes, which includes a three-month phase-in period to the $60bn per month in U.S. Treasuries and $35 billion per month in MBS target caps.

Traders should pay attention to how FOMC members vote on the action taken. Any dissent for a larger 75 bps adjustment could encourage bond markets to price in a more aggressive hiking cycle, boosting U.S. Treasury yields and the U.S. dollar. In this scenario, GBP/USD could sell off.

The Fed will not release any macroeconomic projections today, so all focus will fall on Jerome Powell’s press conference. It is vital to closely scrutinize any comments regarding the tightening roadmap and how quickly the bank wants to get to a neutral stance. Any indication that an accelerated pace of hikes in the near term will reduce the need to raise borrowing costs too much in the future may be viewed as a bearish catalyst for the greenback.

If Powell signals that interest rates adjustments of half a quarter point will be the new normal until data points to a sustained pullback in inflation, the U.S. yield curve could reprice higher, bolstering the U.S. dollar against its major peers, such as the British pound.

On Thursday, the Bank of England is seen lifting its key rate by 25 bps to 1%, the highest level in 13 years and the threshold at which active quantitative tightening could begin, according to previous suggestions (as opposed to simply balance sheet runoff).

On the latter point, the institution led by Andrew Bailey may offer guidance on how it plans to further trim its £847 billion portfolio, though many analysts believe policymakers will punt on the decision until they gather more information, opting to launch a formal review to assess how outright gilt sales will affect financial markets.

The Bank of England will publish macroeconomic projections Thursday. It is important to carefully examine the revisions to the gross domestic product and CPI projections. 2022 GDP is likely to be slashed sharply, while inflation is expected to be revised higherfor the forecast horizon. If the output downgrade is significant, GBP could be penalized in the FX market.

BoE’s tone and guidance will be pivotal for Pound Sterling. With the balance of risks to the UK economy tilted to the downside, amid falling consumer confidence and weakening consumption, the bank may subtly push back against aggressive monetary policy tightening expectations (155 bps of tightening expected by year end in total).

Any hint that the bank may pause its normalization cycle or deliver fewer rate hikes than discounted in the curve may pave the way for a steep GBP/USD retreat.

Traders should also pay attention to how MPC members vote on Thursday. If we see several votes in favor of maintaining interest rates, a firm rejection of the possibility of supersize 50 bp hikes, or a lack of strong rhetoric regarding the inflation, the pound could lose ground against the U.S. dollar.

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