Storm clouds gather for GBP/USD with more short-term pain likely
Partly reflecting the turmoil in global financial markets, GBP has had a bad start to the year plummeting to multi-year lows against USD with more pain likely to come.
The latest blow to GBP came from industrial production, which fell 0.7% between November and October, the biggest decline since 2013. Though a poor number, it doesn’t reflect that the UK is falling into recession, there was the exceptionally mild weather after all, but it does paint a picture of a slowing pace of economic growth.
The rise in US interest rates with more expected this year against a backdrop of possibly no upward move in UK rates has sent GBP/USD crashing through 1.4500, a historically very strong support level. Also, traders should watch for US retail sales and preliminary UoM consumer sentiment this Friday. If they turn out to be robust that could push USD up even more.
When the Bank of England gives its views on the economy and monetary policy on Thursday, it is likely to be dovish reinforcing ongoing GBP/USD weakness. The inflationary threat is low at the moment and the UK economy appears to be catching a bit of a chill from events overseas, which hardly calls for an interest rate rise.
And should the UK property become exceptionally bubbly again, the Bank of England has other means to influence this market other than through interest rates, such as raising mortgage lending standards.
The other dark cloud overhanging GBP is the referendum over whether the UK should stay in the EU. This could come as soon as this Summer and right now polls indicate that the outcome is finely balanced. Should the UK vote to leave the EU, this could see GBP hammered as it would likely trigger a second referendum over whether Scotland stays in the UK and this time it may leave.
In the meantime, there will be plenty of hysteria from both sides of the pro-EU and anti-EU camps with the antis in particular painting a particularly bleak and damming scenario of the UK outside the EU. This could well spook GBP, particularly on days where polls show a majority wanting to out of the EU. In other words, ‘facts’ will be the first casualty in the run up to the referendum.
Nonetheless, it’s worth noting that since 2004, the GBP/USD exchange rate tends not to spend a very long time below 1.4500. The previous occasions that this occurred decisively were in Jan 2009, March 2009 and May 2010. That’s not to say that history will automatically repeat itself, it might be different this time, particularly if there is a Brexit, the economic consequences of which are unknown at this point.
However, it isn’t all rosy for the US economy either. There’s a chance that the Fed’s tightening plans may not get very far. Forward indicators, such as the US bond yield curve is flattening, a sure sign that fixed income investors believe that the US economy is slowing. Recently, US ISM manufacturing data has been slipping and is below 50% - indicating contraction, which is a sign of economic weakness. Meanwhile, employment, which has been growing strongly, is a lagging indicator. If marked weakness starts to show up in the Non-Farm Payroll numbers, then that could spell an end to the US rate tightening cycle and cap the USD rally and see GBP/USD moving back above 1.4500.
TECHNICAL ANALYSIS: GBP/USD – Technicals remain bearish
GBP/USD continues to look very bearish as it plummets into multi-year lows on the back of diverging monetary policy between the UK and the US.
In terms of support, the recent low of 1.4352 is a key level and one which looks vulnerable at the moment. Beyond that levels of 1.4295, 1.4219 and eventually even below 1.4000 are potential targets. If the monetary fortunes of the UK and US begin to look particularly divergent or market turmoil escalates, then lows of 1.3619 reached in March 2009 could be attained.
Resistance can be seen at 1.4541, 1.4604 and 1.4696. Interestingly there is a gap between 1.4604-1.4663 and one which the market may well try to close before moving much lower. Indeed, many of the technical indicators, such as RSI, are showing GBP/USD as oversold, so a short-term bounce is entirely possible.
But over the rest of January, the overall outlook for GBP/USD remains bearish with this Thursday’s BoE statement and US data on Friday potentially reinforcing this outlook.
By Justin Pugsley, Markets Analyst, MahiFX