GBP/USD seen sliding further to September 2020 lowAs U.S. inflation accelerates & Fed tightens in earnestAny GBP/USD rallies likely to be shallow & short-lived

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The Pound to Dollar exchange rate is likely on course for a return to 1.28 and its lowest level since September 2020, according to strategists at Nomura, who say that selling Sterling remains one of their preferred strategies for trading the Federal Reserve’s (Fed) effort to reign in U.S. inflation.

Dollars were sold widely on Wednesday in price action that lifted Pound Sterling back above the 1.31 level and enabled the European single currency to hold for the time being at least, the recently-recovered 1.11 handle.

It’s possible that weakness in the Dollar reflected a combination of market sentiment relating to conflict in the Ukraine and Wednesday’s revelation that German and Spanish inflation surged further this month, which vindicates the European Central Bank for keeping all monetary policy options open.

But with U.S. inflation far more elevated than in Europe at the last reading and the Fed viewed as increasingly likely to lift its interest rate at a pace not seen for decades, many analysts including the team at Nomura expect that declines in the Dollar and rallies by other currencies will be short-lived during the months ahead.

“It’s a long USD view, but one we prefer to express in short GBP/USD to 1.28 with the UK facing a more acute cost of living crisis,” says Jordan Rochester, a strategist at Nomura.

Above: Pound to Dollar rate shown at hourly intervals alongside EUR/USD. Click image for closer inspection.

“We expect EUR/USD to test 1.08. However, as today demonstrates, a surprise ceasefire is the main risk to that view,” Rochester and colleague George Buckley wrote in a Tuesday research briefing

While both are expected to fall over the coming months, the Euro’s sensitivity to fits of hope about a possible end to the conflict in Ukraine is one reason why the Nomura team prefers selling the Pound against the Dollar as opposed to the Euro.

With currencies of Central and Eastern European countries along the Ukrainian and Russian borders aside, the Euro was one of the market’s biggest fallers during the weeks immediately after the Russian military crossed into Ukraine on February 24.

This has seen the Euro and other mainland European currencies benefit disproportionately from market optimism about events on the ground in Ukraine, where a Russian troop withdrawal from the region around Kyiv has given a possibly misleading appearance of de-escalation by Moscow.

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“The negativity on EUR may start to change in April/May if and when the Fed’s hiking cycle has been largely priced in, and we get a more hawkish ECB. From the fiscal side, the potential for EU joint issuance picks up, or China stimulates its economy. We could see a potential ceasefire in Ukraine and/or OPEC steps up and the pressure on energy markets potentially relaxes,” Rochester and Buckley said.

“We expect some combination of this list to help push EUR back towards 1.14 by year-end. That said, this is a list of hopes not certainties, and is why tactically we remain short

GBP/USD looking for 1.28,” they added.

While a recovery by the Euro and Sterling couldn’t be ruled out for later this year and the Dollar may yet succumb to a reversal of bullish wagers built up by the market in recent months, the prospect of an accelerated Fed tightening cycle is still expected to lift the greenback further in the short-term.

But with the Euro subject to the risk of positive headlines pertaining to Ukraine, however misleading or misplaced some of the sentiments might be, selling the Pound-Dollar rate remains the preferred strategy for trading the Fed’s effort to reign in U.S. inflation.

Above: Pound to Dollar rate shown at daily intervals alongside EUR/USD. Click image for closer inspection.

“While the BoE began its tightening cycle in December last year and the Fed three months later, we don’t expect the ECB to end asset purchases for another six months (September) and to raise interest rates for almost another three months after that,” Rochester and Buckley say.

Demand for the Dollar has been weighing on GBP/USD for months already, although Sterling has also recently been burdened itself by growing uncertainty about whether the Bank of England (BoE) will meet market expectations for Bank Rate this year.

This is after the BoE suggested in its March statement that the commodity-induced squeeze on incomes could potentially serve as a substitute for some of the increases in Bank Rate that financial markets have taken as given for later in 2022.

“We are watching very carefully but facing very high levels of uncertainty as to what is the right combination of what I said earlier was the ‘natural and quite substantial hit to real income’ - this terms of trade shock that we’re facing - and the right use of monetary policy,” Governor Andrew Bailey told the economic policy think-tank Bruegel this week.

“We recognise that the overall effect on inflation will be the sum of the two and I think the shock to real income is larger, and I think many commentators say this, than the single effect of monetary policy. But monetary policy is important. Not least because we have to guard against second round effects,” the governor also said on Monday.

Above: Pound to Dollar rate shown at weekly intervals with Fibonacci retracements of 2020 recovery indicating possible areas of medium-term technical support for Sterling, with selected weekly moving-averages.Click image for closer inspection.