Bank of England uncertainty spells volatile week for Sterling
At its last meeting the markets thought it was a dead cert that the Bank of England (BoE) would cut interest rates and it didn’t. The same view prevails that the Aug 4 meeting is also certain to see a rate cut, but there’s still a narrow chance it won’t happen, which would probably buoy sterling.
Following the initial turmoil of the Brexit vote – GBP/USD has found some equilibrium around 1.3100-1.3360 – but that range could be breached depending on what the BoE does on Thursday.
Apart from maybe extending more credit to the banking sector – there’s still some chance the BoE will not cut rates and is not expected to announce a restart of quantitative easing this week
The problem is down to the mixed signals coming from the economy since the June 23 referendum result. On the one hand the BoE’s own agents found that the economy was ticking along fine, UK stocks have rallied strongly and many domestically focussed shares have also recovered, Q2 GDP was a surprisingly strong at 0.6% (a mostly pre-Brexit figure – but it does imply strong economic momentum), houses prices are largely steady and UK exports have been outpacing those of rivals for the first time in over a decade and that was before Sterling’s Brexit plunge.
On the other hand, many economic, business and consumer sentiment surveys, which are forward looking indicators, have nosedived suggesting that a nasty recession could be pending. This week sees more indicators, but unfortunately not much post Brexit hard data for the BoE to form a judgement. Monday sees manufacturing PMI, Tuesday construction PMI and Wednesday its services PMI.
The problem with these surveys is that they might be overly gloomy given the dire predictions made by the remain camp about Brexit. All these seemingly contradictory numbers could give the BoE pause for thought and comments by various members of the Monetary Policy Committee suggest that there is some division of opinion over what to do.
Nonetheless, a 0.25% cut in the base rate from 0.5% might be carried out simply to support confidence. Such a move may not see GBPUSD fall that far given it’s so widely anticipated, but that would also depend on what the BoE says ie if it is very bearish on the UK’s economic prospects, for example. A 0.5% cut – unlikely – could well see GBP/USD crash though 1.3000 as could a very bearish statement. And at this stage the BoE doesn’t seem overly concerned about GBP weakness or inflation – a benefit of the global deflationary environment.
A decision to stand pat, not what the market is expecting, and accompanied by a neutral stance on the economy could see GBP/USD claw back more losses and given the mixed signals from the economy, the BoE might be justified in waiting another month for some hard data to materialise.
TECHNICAL ANALYSIS: GBP/USD – A short-term break in the downtrend?
GBP has earned the dubious distinction of being the worst performing major currency this year and whether or not it continues that trend this week to a large extent depends on the decision by the Bank of England over interest rates on Thursday.
From the perspective of long-term charts, the outlook for GBP/USD remains bearish. It has come nowhere near to recovering its pre-2008 levels and has been in another pattern of decline since July 2014. In that vein, the current recovery from lows of 1.2794 looks very much like a staging post for another fall.
There is still a huge gap on the charts between 1.3533-1.4012, and generally markets like to fill gaps, and this may get filled before more big declines occur. But for the moment it’s very hard to see a catalyst, which could propel GBP/USD all the way to 1.4012 – maybe a very favourable trade deal with the EU would do it – not very likely – and would take several years to negotiate.
But in the meantime, support can be seen at 1.3160, 1.3079 and 1.2904 and resistance: 1.3280, 1.3290, 1.3425 and 1.3435. The RSI has crept back into neutral territory and the slow stochs are still running through a buy signal, which suggest that GBP/USD is well supported and even has the potential to go higher in the short-term.
But ahead of the BoE decision – GBP/USD volatility is likely to drain away and then explode again on the announcement with the potential for dramatic moves if the central bank does nothing or is overly aggressively in its stimulus response.
By Justin Pugsley, Markets Analyst, MahiFX