Forex Analysis & Reviews: 31.07.2023 - Uncertainty looms over...

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31.07.2023 11:22 AM

Uncertainty looms over GBP/USD

You can't envy the Bank of England. Despite its meeting taking place later than the meetings of the Federal Reserve and the European Central Bank, the tasks facing Andrew Bailey and his team appear much more complex than those of their European and American counterparts. Not only is inflation in the UK higher than in the USA and the eurozone, but the degree of political pressure is also off the charts. Economic advisors at the Treasury are certain that the BoE has gone too far and it's time for them to hit the brakes.

The futures market is 70% confident that the Bank of England will follow the example of the Federal Reserve and the European Central Bank and raise the repo rate by 25 basis points to 5.25% at the meeting on August 3. However, Goldman Sachs, HSBC, Barclays, and UBS believe that the move will be more significant. NatWest agrees with them, asserting that the news of inflation slowing to less than 8% in June should not be overestimated. The combination of high prices in the services sector and rapidly rising wages necessitates decisive action from the central bank. If they add only a quarter of a percentage point to the borrowing costs and then experience an acceleration in the Consumer Price Index (CPI), it will amplify the already overwhelming uncertainty.

Volatility and Inflation Dynamics

The increased volatility prevents GBP/USD from showing its potential. Barclays refers to the Bank of England as the last "hawk," which should work in favor of the pound given the imminent end of the monetary restriction cycles by the Federal Reserve and the European Central Bank. Citi believes that if the repo rate increases by 50 basis points in August, the futures market will push its expected ceiling from the current 5.85% to 6.25–6.5%, which will serve as a catalyst for strengthening the pound. Conversely, a 25 basis point increase in borrowing costs will lower expectations to 5.75%. As a result, the British currency will continue to be under pressure.

The chances of a substantial move may be small. It's challenging to be resolute in a stagnant economy, especially based on a single inflation report. A quarter-point increase with a "hawkish" tone seems to be the optimal decision.

Inflation and Bank of England Rate Dynamics

It's essential to consider that not everything in the GBP/USD pair depends on the BoE's verdict. Investors are confused. On one hand, the proximity of the end of the tightening cycle by the Federal Reserve inspires the opponents of the U.S. dollar. It will eventually be followed by a dovish pivot. On the other hand, the decision by the Bank of Japan to ease control over the yield curve poses risks of a rally in treasury rates, making American assets more attractive, attracting capital to North America, and strengthening the greenback.

Thus, the fate of GBP/USD is affected by double uncertainty—both internal and external—which intensifies the risks of consolidation.

Technically, on the daily chart of the analyzed pair, the combination of Three Indians and 1-2-3 patterns increases the chances of a correction continuation to an upward trend and its reversal. Nonetheless, it's best not to rush without an exit from consolidation. Sell GBP/USD from 1.277, buy from 1.3. Prior to that, preference is given to intraday trading with narrow targets.

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*Disclaimer: The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.