GBP/USD Forecast: Dollar Awakens as Sterling’s Political Shield Shatters

• GBP/USD wedge break finally triggers as UK political turmoil hits sterling
• Burnham speculation fuels fears of deeper UK fiscal deterioration
• UK data impresses, but politics and gilt stress dominate
• Dollar technicals and US exceptionalism finally reconnect

Summary

GBP/USD moved sharply lower on Thursday, validating the downside wedge risk highlighted earlier in the week as sterling finally starts reacting negatively to intensifying political turmoil in Britain. What had looked like a curious divergence between deteriorating UK political fundamentals and resilient pound price action now appears to be correcting rapidly, compounded by a simultaneous breakout in the dollar.

Political Turmoil Finally Bites

Political turmoil in Britain continues to intensify following the resignation of former health minister Wes Streeting on Thursday, a move that appears to have emboldened other potential challengers to Prime Minister Keir Starmer, including Andy Burnham, the influential left-leaning mayor widely viewed as one of the biggest threats to Starmer’s leadership.

Burnham’s position became even more important after a Labour MP in Greater Manchester resigned, opening a path for him to return to parliament and, if successful, potentially mount a leadership challenge for the prime minister’s job. Markets are concerned that he may push for even more spending and taxation at a time when Britain’s fiscal outlook is deteriorating and long-end gilts remain under acute pressure.

One way or another, Starmer’s tenure as PM now looks shorter than the half-life of a decaying lettuce.

Politics Overshadows Solid UK Data

What makes the pound’s reversal particularly interesting is that the political turmoil is otherwise distracting from what’s actually been a decent run of form for the UK economy. While Citi economic surprise index only track how incoming data performs relative to expectations rather than outright levels of activity, right now the skew of beats to misses has hit levels not seen since the second half of 2023, helped further on Thursday by stronger-than-expected UK GDP data.

Source: LSEG

The economy expanded 0.6% over the first quarter, well above expectations, with services, manufacturing and construction activity all contributing positively. While seasonal distortions and front-loading tied to the Iran conflict may have flattered the figures, the report reinforced that activity is holding up far better than many feared.

That suggests the pressure on sterling is being driven far more by concerns surrounding political stability and fiscal credibility than a sudden deterioration in the underlying economic pulse.

US Exceptionalism Rolls On

Adding to sterling’s woes, the US economy simply won’t quit. While the UK may be running with a higher Citi economic surprise score than the US, shown in red, US data has consistently topped expectations in aggregate for the better part of the past year apart from a brief dip around Christmas.

That was reinforced again overnight with another solid US retail sales report alongside hot import and export price data, underscoring the inflationary pulse still flowing through the economy. Headline retail sales, sales excluding autos and the closely watched control group measure all rose 0.5% in April, with the latter topping forecasts again and pointing to ongoing resilience in household demand despite higher fuel costs and elevated borrowing rates.

At the same time, import prices surged 1.9% over the month, the largest increase in four years. Excluding food and energy, prices climbed 0.7%, adding to similar signals seen earlier in the week in both CPI and PPI data that inflation pressures may be broadening through the US economy.

Export prices also continued to outperform, helping to bolster the US terms of trade at a time when many other economies are being squeezed by higher imported energy costs. Combined with the stronger activity data, it reinforces the idea the Federal Reserve may need to keep rates higher for longer even as geopolitical tensions intensify.

DXY Breakout Changes the Picture

Source: TradingView

With the data confirming US economic exceptionalism remains alive and well, the curious divergence between the dollar’s fundamental and technical backdrop seen recently may now be in the early stages of converging once again. Instead of breaking lower from the descending triangle it had been coiling within, the narrow dollar index broke above downtrend resistance and reclaimed the 200DMA on Thursday.

From a pure price action perspective, it suggests the dollar’s slide may now be over, with directional risks shifting sideways to higher. Traders should keep a close eye on the 50DMA and 99.31 overhead, with a break above the latter amplifying the risk of a resurgent greenback heading into the northern hemisphere summer.

GBP/USD Technical Outlook

Source: TradingView

Downside break risk from the rising wedge structure in GBP/USD materialised spectacularly on Thursday, with the pair cascading through the moving average zone comprising the 50, 100 and 200-day periods. The price is now within a whisker of completing the roundtrip back towards where the wedge first formed at 1.3381.

With RSI (14) slipping back beneath 50 and MACD now diverging sharply away from the signal line having crossed it from above earlier in the week, the momentum picture is quickly shifting in favour of the bears, putting 1.3348 on the radar should the wedge break extend further. If the latter level were to give way, there’s little visible support evident until 1.3180.

Overhead, the confluence of the 50 and 200-day moving averages now looms as the key zone to watch. Given the momentum picture, rejections from this zone on bounces would make for an appealing entry level for shorts, allowing for stops to be placed above for protection. If the price reclaims the moving average zone, 1.3450 and the 100-day moving average are the immediate levels overhead of note.