Image © Pound Sterling Live
Pound sterling's run higher against the euro is at risk of fatigue, Bank of England guidance will be a potential setback trigger.
The pound's rally against the euro has stalled at the round and psychologically significant 1.20 level, leaving it exposed to a pullback should the Bank of England decline to endorse the market's rate path at noon today.
The pound is softer in early Thursday trade: the pound-to-euro exchange rate is at 1.1979, down 0.13% on the day the Bank of England will raise Bank Rate to 4.0%.
GBP/EUR has yet to post a daily close above 1.20, a sign that layered orders sit at the level from investors taking profit and from traders betting on a rebuff.
The 1.20 level also marks the upper end of the post-Brexit range, although the pair has recorded interim highs above 1.21.
Above: GBP/EUR at daily intervals with the 21-day (blue) and 100-day (red) moving averages.
The recent rally has been significant, but leaves the exchange rate overbought, which regular readers will know we have been banging on about for weeks now. GBP/EUR's 21-day moving average, at 1.1906, has pulled far above the 100-day average at 1.1725 during the October rally.
Pound Sterling Live's modelling treats mean reversion as a powerful driver of short-term price action, so the pair is expected to mean-revert through consolidation and a mild pullback over the coming days and weeks.
As the chart shows, we're looking for the 21-day and the 100-day moving averages to 'close the loop'; that would naturally entail the exchange rate pausing the rally, at the very least.
Today's Bank of England is a likely catalyst for a pullback, and investment bank analysts agree with the market pricing for a quarter-point hike today that takes Bank Rate to 4.0% from 3.75%.
The pound is exposed to the guidance that accompanies the decision, because money markets price around four hikes in total in this cycle.
Should the Bank signal fewer hikes than that, the pound would lose part of its rate support, something that might be interpreted as a 'dovish hike'.
Analysts Doubt the Bank of England Delivers Four Hikes
SEB expects today's move to be followed by one more hike at most, possibly in February, "markets price in around four hikes in total, which we consider too hawkish," says the Swedish bank.
Berenberg expects the Bank to hold in December, "if energy prices recede, we think that the BoE will hike just once," says the German private bank.
Brent crude fell more than 8% on Wednesday on optimism over a quicker end to the Iran conflict, easing the energy-price pressure behind the Bank's tightening.
Commonwealth Bank of Australia disputes the market pricing for a series of further hikes, and says an eventual unwind of that pricing will push the Australian dollar higher against the pound.
Elsewhere, Crédit Agricole's FAST FX model, its systematic measure of short-term fair value, shows the euro is more than 1.5 standard deviations undervalued against the pound. The model has triggered a long EUR/GBP position with a take-profit at 0.8469 (GBP/EUR at 1.1808).
However, UK services activity accelerated in October, with the final services PMI released on Wednesday rising to 52.8 from 52.1.
"Resilient growth and sticky inflation mean the MPC can hike multiple times over the coming months," says Pantheon Macroeconomics.
ING also judges a follow-up hike in February more likely than not.
Pound Sterling Live Expects Any Setback to Be Shallow
The pound should find support on any dip against the euro given those upside risks to UK rates, as argued in Pound Sterling Live's Bank of England preview.
Pound Sterling Live continues to hold a constructive medium-term view on the pound; the UK economy is outperforming and the euro is undermined by French fiscal stress.
A retracement towards the 21-day average at 1.1906 should be seen as a minor setback within the uptrend.
Pound sterling needs a daily close above 1.20 against the euro to resume its rally.
