BRITISH POUND FORECAST:
- GBP/USD takes a turn to the downside as traders pare back bets on Bank of England future rate hikes
- Market pricing on monetary policy, however, could turn more hawkish in the coming weeks as red-hot UK inflation will likely required a more aggressive response from the central bank
- This article looks at cable’s key technical levels to keep an eye on in the near term
Most Read: April UK Inflation Hits a 40-Year High at 9%, GBP/USD Slides
After staging its biggest rally in 17 months on Tuesday, the British pound reversed course on Wednesday and took a sharp downward turn, sliding 0.65% to 1.2411, as traders pared back money market bets on Bank of England future rate hikes following slightly lower-than-anticipated inflation data.
By way of context, the April UK consumer price index rose 2.5% m-o-m and 9.0% y-o-y, a tenth of a percent below consensus expectations. While this was the first time that the report did not surprise on the upside in recent months, it is misguided to believe that in itself is a victory, given that price pressures continued to broaden, pushing the cost of living to a new four-decade high.
With CPI expected to climb to double digits during the second quarter, and rising wages threatening to exacerbate the trend, the central bank will likely become more hawkish over the coming weeks and signaled it will have to pull back accommodation more aggressively despite rapidly slowing growth.
True, the likelihood of a recession has increased sharply of late, but the UK labor market is still in a good place and should withstand a steeper path of interest rate hikes without collapsing. In any case, policymakers, who now face a large credibility problem, may soon recognize that it is better to go hard now on the tightening cycle to restore price stability than to risk a long-term stagflationary slump that that could be far more damaging to the economy.
If markets begin to price in a more forceful monetary policy response to the current inflationary environment from the BoE, GBP/USD should stabilize and manage to retrace some of the 2022 losses, especially as the Fed has ruled out supersized 75 bps hikes for now. However, any recovery in sterling should be moderate, as headwinds affecting the UK economy are likely to reduce appetite for long positions in the European currency.
In terms of technical analysis, despite Wednesday’s sharp pullback, cable remains above the psychological 1.2400 level at the time of this writing. If traders manage to defend this support and spark a rebound in the coming sessions, the first resistance to consider appears at 1.2650, followed by 1.2835. On the flip side, if downside pressure accelerates and sellers breach the 1.2400 area decisively, GBP/USD could be on its way to retest its 2022 lows in short order.
GBP/USD TECHNICAL CHART
GBP/USD Chart Prepared Using TradingView
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—Written by Diego Colman, Market Strategist for DailyFX