UK currency strength to be tested this week

Focus will return to fundamentals this week after the UK general election delivered an unexpected majority Conservative government and the GBP appreciated strongly in response. 

While economic outperformance is expected to support further EURGBP downside, the initial GBPUSD response to previous political event outcomes has not tended to persist and relative BoE-Fed monetary policy should place downward pressure on GBPUSD over the coming year. 

Furthermore, a Conservative victory means an EU referendum is set to occur before the end of 2017 and supports a higher medium-term GBP political risk premium.

This week, GBP strength will be tested by the Bank of England Inflation Report (Wednesday), following the May rate decision (Monday), as well as industrial and manufacturing output (Tuesday) and labour market data (Wednesday). 

While the BoE is widely expected to leave policy settings unchanged on Monday, the May Inflation Report is likely to include downward revisions to its near-term inflation and GDP forecasts, given recent disappointing data

Governor Carney may indicate a degree of comfort with current interest rate market pricing, which implies the first BoE rate hike in Q2 16

In terms of data, March industrial production is expected to increase 0.1% m/m (consensus: 0.0%) and the market expects manufacturing production to increase 0.3% m/m. 

The March labour market report is likely to show a new drop in unemployment to 5.5% (consensus: 5.5%; last 5.6%), in line with the previous month's claimant count. 

"We expect wages to pick up slightly, to 1.8% 3m/y (consensus: 1.7%), as core earnings continue to recover (+1.9% 3m/y; consensus: 2.1%). The pace of decline in jobless claims is likely to moderate in April to 15k, the slowest in two years (consensus: -20k)", says Barclays