GBP/USD bulls give ground back to the bears as the US dollar firms ahead of the ECB

• GBP/USD pressured by a stronger US dollar ahead of the ECB.
• Italian politics is taking up the front pages in the financials, weighing on the euro. 

At 1.1967, GBP/USD is losing some 0.24% from a high of 1.2037 and has fallen to a low of 1.1953 with the US dollar edging higher ahead of a rate decision by the European Central Bank on Thursday and amidst yet more political uncertainty across the pond. 

The US dollar has benefitted from its safe haven status as the euro struggles in the run-up to a potentially eventful day on Thursday with the ECB meeting. However, Italian politics has been at the fore of action this week, so far, with potentially months of upheaval.

Italian Prime Minister Mario Draghi asked on Wednesday for the upper house Senate to hold a confidence vote that will effectively decide if his coalition government stays in office. However, despite winning the Senate Confidence motion, Draghi previously said he would not continue without the support of his coalition partner, the Five Star Movement. This means that an early election will be called in the nation which is a weight on the euro, potentially beneficial to the US dollar and therefore a thorn in the side for the sterling bulls. 

Meanwhile, back on UK shores, net short GBP positions increased for a second consecutive week last week as politics on home soil are also a burden for the nation's currency.  The UK will have a lame duck prime minister until September when a new leader will be announced. The leadership battle has raised risks surrounding the Bank of England's independence, which could undermine the pound further analysts at Rabobank said. 

''The UK Tory party leadership race has sparked comments from Foreign Secretary Truss that she may set limits to the BoE’s independence if she were PM. Insofar as Truss is in favour of large unfunded tax giveaway, this hints at government policy of loose fiscal and tight monetary conditions which would likely erode the Bank’s credibility and result in even more investors turning their backs on GBP.''

Meanwhile, the inflation data in the UK has surprised to the upside for June. Headline inflation rose to 9.4% YoY (consensus: 9.3%) from 9.1% in May, with core inflation easing slightly to 5.8% from 5.9%. The consensus is that inflation will continue rising in the UK over the coming months. The firmness in inflation combined with ongoing tightness in the labour market will mean that the BoE will have to raise rates aggressively, despite the elevated risk of recession. The markets are pricing in a move of 50bp to 1.75% in August, followed by 25bp hikes in subsequent meetings, with the policy rate peaking at 2.5% by December.