GBP/USD pares back to mid-1.2500 pre-US data as post-UK fiscal stimulus optimism fades

• GBP/USD has pulled back from a fiscal stimulus inspired jump above 1.2600 ahead of US data/amid Brexit headlines.
• The pair is back to trading in the 1.2560s, despite Sunak’s announcement of significant further aid for low-income households.

GBP/USD jumped momentarily to fresh near three-week peaks above 1.2600 in earlier trade as sterling got a boost on reports alleging that UK Chancellor of the Exchequer Rishi Sunak could be about to announce significant further targetted support for UK consumers suffering amid the worst cost-of-living crisis in the UK in decades. In a recent announcement, Sunak appeared to exceed these expectations, announcing a new combination of grants and one-off energy-related payments that would take the total support fiscal aid dished out to consumers since the start of the cost-of-living crisis to around £37 billion.

Despite this, GBP/USD has waned back from earlier session highs and now back to trading slightly in the red in the 1.2560s. Currency traders may have been inclined to book some sterling profits ahead of a test of monthly highs in the 1.2630s prior to the upcoming release of the second estimate of US Q1 GDP growth and weekly jobless claims figures at 1230GMT. In the absence of any surprises, the buck may once again fall under modest selling pressure, as focus returns to the Fed in wake of Wednesday’s release of the minutes from the latest meeting.

To recap, while the minutes showed a strong backing on the FOMC for 50 bps rate hikes at the Fed’s next two meetings, there were no standout hawkish surprises. Indeed, analysts said that the tone of the minutes lent itself towards FOMC members favouring a pause or slowdown in rate hikes once rates have reached the neutral level later in the year (inflation allowing), where the Fed could then reassess the need for further tightening. Long-term US bond yields have been dropping as of late as US recession fears rise and hawkish Fed bets are pared back and should this trend continue, GBP/USD can get back above 1.2600.

But one big potential downside risk to be cognizant of is Brexit tensions. Reports this morning suggested that the UK government will be introducing legislation as soon as 6 June that would enable the UK to make unilateral tweaks to its adherence to the Northern Ireland Protocol (NIP). The EU has threatened that if the UK does unilaterally ditch the NIP, they might respond by scrapping the post-Brexit trade deal with the UK. This would be a catastrophe for the already weak, stagflationary UK economy and could weigh heavily on sterling if trade tensions with the EU continue to mount.