GBPUSD: Is it time for reversal?

1:10 PM 26 June 2018

Summary:

  • Bank of England sharpens its rhetoric making a rate hike in August much more realistic
  • UK economic data surprise index may have already bottomed out (retail sales surged)
  • PM Theresa May wins an important voting ahead of a EU summit this week
  • Positioning data shows GBP net longs falling to the lowest since September

The second quarter of this year is slowly coming to an end, and the British currency cannot say it has had a fruitful period of time. The pound lost over 5.5% against the US dollar being able to make just a modest gain (less than 0.8% at the time of writing) against the Swedish krona in the G10 spectrum. Meanwhile, the backdrop for the pound seems to have evolved in favour of the currency, hence expectations of the stronger pound do not appear to be baseless. In today’s analysis we provide several reasons why the GBP could see a bounce over the coming weeks.

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The paramount point comes obviously from monetary policy where we were offered a hawkish shift last week. While the BoE chose to leave rates on hold it simultaneously decided to alter the projection when it comes to balance sheet adjustment (something the Fed’s been doing for a while). The Bank expects it may happen once the main rate is raised 1.5% (2% previously) so it’s obviously a hawkish change. Moreover, there was one additional vote if favour of a 25 basis point rate hike in June as the BoE Chief Economist Andy Haldane entered a hawks’ camp. Overall, the MPC shared the same view that gradual monetary tightening was appropriate given the current economic conditions. In our view these are major changes that few had expected prior to the meeting and it could provide some relief for the troubled pound. Notice that the OIS-implied odds for a hike at a meeting in August stand around 70% suggesting there could be still some scope for the GBP to appreciate when the BoE pulls the trigger.

link do file download linkThe UK-US economic surprise index calculated by Citi has recently reached its lowest levels for years suggesting a turning point could be in sight. Source: Bloomberg, XTB Research

Another reason for the stronger pound may be localized in the macroeconomic data. Take a look at the chart above to see how UK and US releases have looked lately against market expectations. Citi economic surprise indices measure how much macroeconomic readings differ from consensuses, hence better than expected data leads to higher levels of the index. The chart above shows that macroeconomic releases in the US have managed to beat expectations much more often compared to those in the United Kingdom. However, each streak has its end (data cannot get worse indefinitely as a bar placed by economist moves lower), and given the data for the last 10 years or so one may spot that we have recently touched one of the lowest points over this period. It may suggest that the spread may reverse soon. For example, UK retail sales for May smashed expectations while regional economic activity indices (Philadelphia, Chicago) as well as manufacturing PMI from the US fell short of expectations. It could be just a stirring of the trend reversal.

link do file download linkUK retail sales deflator has bounced back of late after reaching its lowest point this year suggesting higher retail sales prices might filter into broad CPI. Source: Macrobond, XTB Research

As we already pointed out May retail sales were boosted by a royal wedding as well as warm weather and a base was not high either. Anyway, the most important point is a rise of retail sales deflator boding well for domestic inflationary pressures if sustained. It could act in favour of an August rate increase boosting BoE’s confidence to resume gradual monetary tightening amid disappearing labour slack.

The relatively rosy outlook for the pound is clouded a bit by Brexit, nevertheless recent developments have been rather GBP positive. Let’s recall that UK PM Theresa May managed to repel a threat coming from some rebels within her government who tried provide lawmakers with the power to intervene if no Brexit deal is reached before the deadline in March next year. Having said that, the crunch time is still ahead as both sides are expected to agree an outline of future relations at a EU summit in October. Before it happens, we will have another EU summit already this week (28 June) where discussions with regard to a Northern Ireland border may take place. Bear in mind that when Brexit officially happens on 29 March 2019, we will enter a transition period which is expected to last until the end of 2020 (it will be a period of time to allow businesses and others to prepare for the moment once new rules between the UK and the EU come into effect). It looks that till October Brexit-related risks could be contained, but they could resurface during the last quarter.

link do file download linkCFTC shows the GBP net long position moved to its lowest point since September. Source: Bloomberg, XTB Research

Last but not least, the CFTC data produced some notable changes in major currencies, including the GBP. The net long position slumped to the lowest since September last year as some GBP bulls decided to concede defeat. Given the improved monetary policy outlook, contained Brexit risks in the near-term, and a possible turnaround in the US dollar one may argue that the British pound could be among top pickers amid currency investors.

link do file download linkTechnically the GBPUSD drew an encouraging candlestick last week which occurred nearby a strong demand zone as well as a 50% retracement of the whole bullish swing begun in January 2017. Given the current price action one may consider entering a long with a stop below 1.3050, and at a target of 1.36 (before this level is reached the price might struggle with a 38.2% retracement) followed by 1.38. Source: xStation5

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Disclaimer

This article is provided for general information purposes only. Any opinions, analyses, prices or other content is provided for educational purposes and does not constitute investment advice or a recommendation. Any research has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Any information provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it.

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