GBP/USD slips back under 1.3500 in holiday-thinned trading conditions, set to end month with decent gains

• GBP/USD has sliped back under 1.3500 but remains close to monthly highs amid choppy, holiday-thinned trading conditions.
• Following a BoE hike and improvement in Omicron-related sentiment, the pair is on course for a 1.4% monthly gain.

In thin trading conditions on the final day of 2021, GBP/USD is choppy and recently slipped back under the 1.3500 handle. Trading conditions are subdued with many European markets closed for the day and markets in the UK and France shutting early. Though the pair is down about 0.15% on the day as its trades in the 1.3475 area, it only trades about 0.4% below monthly highs hit earlier this week in the 1.3520s. Following a surprise (to some) 15bps rate hike from the BoE midway through the month coupled with a substantial improvement in the market’s appetite for risk as perceived risks to the global economy from the spread of Omicron subside, GBP/USD is on course to post a 1.4% gain on the month.

However, if the GBP/USD closes out the year at current levels, that would mean an annual loss of slightly more than 1.0%. Despite one of the strongest growth rates in the G10 in 2021 for the UK economy and a comparatively hawkish BoE, GBP has been unable to resist the advances of the US dollar, which has powered higher throughout the year as surging US inflation brought forward expectations for Fed policy normalisation. Indeed, some market participants are betting that the bank might immediately commence rate hikes right after the bank’s QE programme ends in March 2022.

Looking at the pair on a shorter time horizon, the fact that GBP/USD ran into resistance just above 1.3500 and failed to push above this level suggests that, for now, further gains may have to wait until the new year. The fact that the pair was able to clear its 50-day moving average with ease earlier in the week suggests that the short-term technical momentum is looking good. As long as the UK economy doesn’t face too much disruption from the spread of Omicron, thus keeping the BoE on course for another rate hike in February, the short-term fundamentals look positive for GBP as well. News on Friday that the UK’s drug regulatory had approved Pfizer’s highly effective at-home Covid-19 treatment pill Paxlovid may further support this positive narrative.

But some FX strategists think that the US dollar, which has pulled back sharply from earlier monthly highs despite continued evidence of elevated inflation, a hot labour market, strong growth conditions and a hawkishly shifting Fed, is overdue a short-term rebound. Perhaps further strong data in the form of next week’s US December labour market reports and December ISM PMI surveys could provide the catalyst for such a rebound. Key levels of support to keep an eye on if the bearish scenario unfolds would be in the 1.3375 area and then the 2021 lows in the 1.3160s.