After April's Inflation Shock, What Next for GBP/USD?

The news was most unwelcome. Far exceeding expectations, the UK’s inflation rate jumped almost a full percentage point to 3.5% (y-o-y) in April. Most frustrating was that this outcome was largely of the government’s own making. Planned rises in taxes and utility bills all contributed to the upside surprise. Furthermore, the inflationary pass-through of hikes to employers’ national insurance and the minimum wage will trickle through in the coming months, moving the Bank of England further from its elusive 2.0% target.

At the same time the country is crying out for something, anything, to boost growth. Q1’s 0.7% (q-o-q) outcome was likely an aberration driven by a desire of exporters to get ahead of Trump’s tariffs. Other leading indicators – unemployment, consumer and business sentiment - point towards a protracted downturn.

Bank of England's stance

Nonetheless, the renewed stubbornness of inflation has at least provided us with one thing – clarity. The three-way vote split at the Bank of England’s May 8 meeting had kept everyone guessing as to its next steps. Yet now, the arguments have moved decisively in favour of the previously isolated policy hawks. This includes the Bank’s chief economist, Huw Pill, who is increasingly outspoken in his belief that rate cuts have been too quick given the ‘stuttering’ momentum of disinflation. A charge more acute given the Bank still faces a credibility gap after its slow response to the post-Covid inflation surge.

Impact on the pound (GBP)

The result of all this? The pound has risen to its highest level against the dollar since February 2022, as expectations for further policy loosening have been dialled back to a single 25bps cut by year-end. Just one month ago the expectation was for two, or even three cuts. Added to this, the UK has managed to find its way into Trump’s good books. It has avoided the worst of his punitive tariffs, and even agreed a bare-bones trade deal. This marks the UK out as a relative haven in a world pummelled by Trump’s brand of diplomacy, lending a further fillip to GDP/USD prospects.

The US half of the equation

Of course, what is going on in the UK is only one half of the equation. If anything, things are more precarious on the other side of the Atlantic. Policymakers at the Fed have been shocked into inaction after repeatedly having the rug pulled out from under them by Trump’s erratic approach to governing. Their dual mandate is to maximise employment whilst maintaining price stability. But how can they assess the economic and inflationary impact of tariffs when calculations are seemingly made on the back of an envelope? That is, if they are not abandoned at the last minute...

Outlook for GBP/USD

Yet, Trump’s recent softening, particularly his inexplicable climb down with China, may give the Fed confidence to resume its prior path of policy loosening, having paused at its last three meetings despite immense pressure (and personal attacks) from Trump. Currently, markets are pricing in two/three quarter point cuts by year-end, an outcome which would cast GBP/USD in a positive light if realised. That is a big ‘if’, though. As we all know, the US political environment can change with a single tweet. Brace yourselves.