To say this week has been a poor one for the British pound is an understatement. The downbeat currency – already reeling from ongoing Brexit and political uncertainties – has been hit further by disappointing domestic economic data. Investors have been left wondering whether the soft data may have any implications on the Bank of England’s decision to hike interest rates next month. Although a 25 basis point rate rise is still likely, the probability of a no change has risen thanks to the disappointing wages, inflation and now retail sales figures.
Among the sterling crosses, the GBP/USD has been hit the hardest because of the fact the US dollar has strengthened further, owing to hawkish talk from the Federal Reserve Chairman Jerome Powell. The Fed is now very likely to hike rates two more times in 2018 and possibly a couple of more times in the first half of next year. It is because of growing expectations that monetary policy will tighten faster in the US than anywhere else across the developed economies that’s helping the dollar the most. As a result of the dollar’s ongoing rally and disappointing UK data, the cable today fell below the psychologically-important 1.30 handle.
UK retail sales, inflation and wages all disappoint
The latest trigger for the pound’s slide was news of an unexpected 0.5% drop in UK retail sales for the month of June, against a prior expectations of a small increase. Earlier this week, the pound had been undermined by soft wages and inflation data. As a reminder, total pay levels rose at an annual rate of 2.5% in the three months to May, unchanged from April, while regular pay growth, which excludes bonuses, rose 2.7% over the same period, down from 2.8% in the three months to April. The unemployment rate remained unchanged at 4.2% as expected. But more up-to-date labour market data revealed that jobless claims rose by 7,800 in June, which was more than 2,300 expected. Meanwhile the headline consumer price index (CPI) measure of inflation remained unchanged at 2.4% year-over-year in June. This was below expectations for a rise to 2.6%. Core CPI eased to 1.9% from 2.1% previously, while other key measures of inflation, including the Retail Price Index, House Price Index and Producer Price Index (both input and output prices) all disappointed expectations, too. The ONS said the increase in transport costs were offset by falling prices of food, clothes and recreation and culture.
Will BoE hike anyway?
So, overall, this week’s data from the UK disappointed but it remains to been seen whether the Bank of England’s policy makers will react to one month’s worth of data, which can be quite volatile. If the BoE wants to tighten its belt, perhaps to give itself some ammunition in the event the economy falls into recession again, now is probably the best time to hike rates because the pound is weak. Delaying the decision could be risky for many reasons. The exchange rate, for one, may have appreciated anyway by the time it starts hiking rates. There is also the risk of overcooking inflation if rates are left low for too long. Furthermore, economic data in July may turn out to be a lot better thanks to the hot weather and England’s unexpected ‘success’ at the FIFA Wold Cup, which is likely to have benefitted some sectors of the economy.
Profit-taking could support GBP/USD recovery
While everything – from soft UK data to ongoing Brexit-related political uncertainty – points to further weakness for the pound, the negativity may have been mostly priced in by now. What’s more, there are no further major economic data left for this week to impact the cable, with the next important data being the US GDP on Friday of next week. The only thing left is momentum. Therefore, the prospects of profit-taking from the bearish market participants could help fuel an unexpected short-squeeze rally in the pound. But for the pound’s longer term outlook to turn bullish we will need to see a positive change in fundamental data or political outlook, and ideally backed by evidence of a technical turnaround. Until these conditions are met, any short term bounces in sterling should be taken with a pinch of salt.
GBP/USD probes liquidity below critical 1.30 level
Taking the above points into consideration, the GBP/USD may in the coming days form at least a short-term base around the 1.30 handle, but so far we haven’t seen any evidence of it doing so. We are nonetheless on the lookout for a bear trap to be formed here as we think prices are oversold. In fact, the Relative Strength Index (RSI) is in the state of forming a positive divergence with price. The higher low on the RSI indicator relative to the lower low on the GBP/USD suggests the bearish momentum may be waning. But the most important indicator is price itself. So far, price action looks bearish and until and unless this changes, the path of least resistance remains to the downside. Short-term resistance now comes in at 1.3050-1.3100. A potential move above here could pave the way to the next resistance at 1.3220. But any move back above the most recent high of 1.3290 and the bearish bias would end, for then we will have a short-term higher high in place and price will have moved above its bearish trend line too. Meanwhile in terms of downside targets below 1.30 handle are the Fibonacci levels shown on the chart. The long-term 61.8% retracement level from the post-Brexit rally comes in at just below 1.2900, which is sandwiched between the 127.2 and 161.8 percent Fibonacci extension levels from the most recent corrective upswing.