After a great performance in 2017, the good times for the British pound look set to continue. While manufacturing and construction PMIs announced earlier this week missed expectations, services PMIs beat optimistic expectations. Given the forward-looking nature of PMI surveys, upcoming GDP growth should remain strong. As services dominate the UK’s exports, this news was well-received in foreign exchange markets and the pound rose following the announcement. Looking onto the horizon, we believe the pound can continue rallying thanks to strong regional growth, moderate sentiment and the historically low value of the pound relative to other currencies.

High growth and low inflation bode well for GBP

The pound tends to appreciate during global economic booms. Looking back at history, the currency was strongest during the 2005-2007 pre-financial crisis era and during the 2013-2014 bull market. Given that the Eurozone is the UK’s biggest destination for services exports, the pound also tends to track the fortunes of the euro.

Thanks to strong growth in the Eurozone and accelerating manufacturing PMIs, regional growth is likely to remain strong. On the other hand, weak inflation is likely to limit any monetary policy response via higher interest rates. An overview of recent growth and inflation in the Eurozone is shown below for reference:

Accelerating growth, low inflation = bull market

Source: Eurostat, note Q4 2017 CPI based on estimate of 1.5% for December

Pound sentiment is bullish, but not at dangerous levels

Looking at trader sentiment, the last time GBP/USD surpassed 1.35 (in early December 2017) the pound was looking overbought. We made this judgment based on both technical indicators and looking at speculator net positions on US futures exchanges. At the time, we wrote that the short-term optimism behind the pound was looking stretched. GBP/USD weakened shortly after we published our thoughts. Funnily enough, the pound was also looking overbought in late September 2017 when GBP/USD was also above 1.35. After we wrote that the pound was susceptible to a pullback at the time, the currency soon weakened.

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