GBP/USD May Climb As Inflation, Trade Data Highlight BOE's Conundrum
With credit market conditions still tight, Bank of England Governor Mervyn King and his Monetary Policy Committee cut rate by 25bp to 5.25% on February 7. Indeed, the situation for the UK looks grim as the policy statement essentially said that the MPC was more concerned that slowing growth will bring inflation below target than they are concerned that inflation will accelerate out of control, suggesting that more rate cuts may loom on the horizon as long as economic data points to deteriorating conditions. This conundrum may be highlighted next week as UK input and output cost growth is forecasted to surge, while the UK visible trade balance is expected to show that exports continue to suffer.
What Are The Markets Facing?
Given the rapid gains in oil and other commodity prices, there are well-warranted concerns that global inflation will rise significantly. The prospect of increased price pressures only compounds the problems that the Bank of England already faces as they contend with mounting downside risks to growth and uncertainty surrounding the ongoing reappraisal of risk in the financial markets. With credit market conditions still tight, Bank of England Governor Mervyn King and his Monetary Policy Committee cut rate by 25bp to 5.25% on February 7. Indeed, the situation for the UK looks grim as the policy statement essentially said that the MPC was more concerned that slowing growth will bring inflation below target than they are concerned that inflation will accelerate out of control, suggesting that more rate cuts may loom on the horizon as long as economic data points to deteriorating conditions. This conundrum may be highlighted next week as UK input and output cost growth is forecasted to surge, while the UK visible trade balance is expected to show that exports continue to suffer. The producer price data not only suggests that broad inflation pressures are mounting, but also that companies are feeling the squeeze on their profit margins as they are unable to pass through the increased costs to their customers. Furthermore, the trade data may reflect consistent weakness in foreign demand for British goods will weigh heavily on the economy, as we’ve already seen industrial and manufacturing production drop. The news will set the stage for the release of CPI on Tuesday, which is anticipated to show that consumer price growth accelerated faster than the Bank of England’s 2.0 percent target once again, but with the economy the primary concern of the MPC at this juncture, it may not prevent the central bank from cutting rates again in the near-term.
Bonds – 10-Year Long Gilt Futures
While Gilts continue to look bullish on the daily charts, the contract may continue to pull back towards 110.07/12 and trendline support at 110.00. The January 22 daily candle hints at a sustained bearish turn, and upcoming UK data may help weigh Gilts down. Indeed, producer price figures are expected to highlight that inflation pressures still persist. While this isn’t likely to keep the BOE from maintaining their dovish tone, traders may sell Gilts down anyway. On the other hand, risk aversion in the markets may take hold once again and lift Gilts towards the 111 level.
FX – GBP/USD
While the Bank of England’s decision to cut rates on February 7 weighed GBP/USD down for a test of 1.9400, the pair has since recovered slightly. Will the central bank’s dovish bias lead to additional losses for the British pound? If past rate decisions are any indication, not within the next few days. Indeed, following the December rate cut, Cable managed to bounce over the course of the following week – and that policy decision was actually unexpected. This time around, the forex markets had been pricing in the 25bp reduction, and given the stability found at 1.94 and the move in 240 minute RSI away from oversold levels, the pair is likely to target at least 1.9650. Upcoming UK data will add to the mix, as PPI is forecasted to surge even higher. On the other hand, the Visible Trade Balance is anticipated to reflect a large deficit, as foreign demand for British goods remains weak. Data in line with expectations will highlight the issue of weak growth and strong inflation that the BOE faces, but traders may keep a closer eye on the PPI figures as they tend to be a bit more market moving.
Has the British pound found a bottom or are more declines in store? Discuss the topic in the DailyFX GBP/USD Forum.
Equities – FTSE 100 Index
The FTSE 100 has run into support near 5,700, though the general trend for the index remains to the downside given the drop from resistance at 6,025. Monday’s UK event risk could tip the index even lower, as rising producer price inflation will put additional pressure on the UK economy. Indeed, deteriorating conditions in the UK have already forced the Bank of England to reduce interest rates by 25bp in December and once again in February. Counter to what some believe, the rate cuts have done little to help boost shares in the UK – as the Federal Reserve rate cuts have not helped US equities – and with the Bank of England remaining open to additional reductions in the overnight lending rate, the FTSE 100 may have far lower to fall.
Written by Terri Belkas, Currency Analyst, Forex Capital Markets LLC, DailyFX.com
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