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British Pound (GBP) on 18/02: Sterling Hit by Falling Inflation, Downside Predicted to be Protected Though

By Gary Howes
British pound and inflation release

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    Another big day for GBP lies ahead

    Tomorrow morning at 09:30 we expect a flurry of activity in the pound exchange rate complex.

    We have the release of minutes from the February MPC meeting at the Bank of England. However, because we have also had the quarterly inflation report last week we would expect reaction to be muted.

    The big deal will be the release of employment data. We won't be overly concerned about the unemployment rate, rather we will be looking for signs that wage growth is picking up. This would be a sign that slack in the economy is picking up as workers become more productive and are paid accordingly. Analysts are forecasting a reading of 0.9% for Average Earnings excluding Bonus (3Mo/Yr) (Dec). Average Earnings including Bonus (3Mo/Yr) (Dec) is expected at 1 pct.

    16:50: Ultimately, today's inflation data will boost the pound

    Neil Staines at the ECU Group gives a counter-view to the idea that low inflation is bad for the UK currency. It is all about timeframes, of course:

    "The lower inflation print may assist in the BoE’s message (and desire) to maintain rates lower for longer than the market expects as a result of GBP strength (Perhaps ironically the exact opposite of the situation facing the RBA) and in doing so may be viewed as a short term GBP negative as a function of reduced interest rate spread support for GBP. However, in our view the medium term effects of the resultant boost to the growth backdrop will continue to suggest economic divergence in favour of the UK and ultimately the pound."

    16:39: Potential for upside acceleration

    "Cable has been on the offer after worse-than-expected UK inflation figures. However, the pair has managed to bounce back and break through the prior downside breakout level at 1.6695. This should, in theory, mean that short-term limits have now been filled on the second wave down. This is now giving scope for potential upside acceleration if the spot were to manage to break through the 1.6708 level in afternoon trading; a break level where we shall also be establishing a long positioning in GBPUSD." - Kristian Siggaard-Jensen at Saxo Group.

    16:13: At some point GBP/EUR should accelerate higher

    Afex give a longer-dated forecast for the pound euro exchange rate:

    "The response of values to successive new highs over recent months has been to sell-off and thus further gains may well prove unsustainable again in coming days.

    "However, from a broad standpoint, a well established series of ascending weekly peaks/troughs is apparent and on this basis any such set-back would most probably be corrective only. Dips have localised support at 1.2120/30 and much more obvious/strong demand in the 1.2000 region, below which negative risk is seen as limited in any case.

    "At some point prices should accelerate away on the upside, rather than "stair-case" higher as has been the case of late, but with GBP/USD also now approaching key resistance levels some caution is probably warranted here initially."

    14:28: Sterling recovers vs USD, down vs EUR

    Continued all-round euro strength has robbed GBP of a potential recovery in the EUR/GBP pair which remains 0.4 pct in the red.

    However, the UK currency has seen recoveries elsewhere, most notable against the US dollar, the outlook for GBP/USD remains constructive as our latest technical outlook note confirms.

    14:15: Weak inflation confirms no rate rise till Q2 15

    "We view relatively weak earnings growth and strength in the pound's effective exchange rate as key inputs to this relatively low inflation outlook. This goes hand in hand with our call that the BoE will stay on hold until Q2 2015." - Barclays.

    13:30: GBP still constructive

    Luc Luyet at MIG Bank says the bias on Cable remains constructive:

    "GBP/USD has broken the key resistance at 1.6668 (24/01/2014 high). However, yesterday's bearish reversal (shooting star) suggests a short-term exhaustion of the buying interest. A break of the support at 1.6693 would confirm a weakening trend and call for a deeper correction. Another support can be found at 1.6600. A resistance now stands at 1.6823.

    "In the longer term, the technical structure favours a bullish bias as long as the support at 1.6220 (17/12/2013 low) holds. The decisive break of the resistance at 1.6668 opens the way for a move towards the major resistance at 1.7043 (05/08/2009 high). However, a sustainable move above that level is unlikely in the next few weeks."

    12:39: Eurozone corporates tipped to keep EUR buoyant

    European corporates are still under-hedged and could limit short-term Euro weakness warn Bank of America Merrill Lynch.

    BofA's Athanasios Vamvakidis says:

    "Our recent reports have been emphasising the importance of flows in understanding the Euro's resilience so far in 2014. EUR/USD has been range-bound, driven by a number of offsetting forces, and flows have been a key determinant for the Euro within its current range. Indeed, we have recently said that the Euro has been supported by strong equity flows, despite the market sell-off in most of the rest of the world so far in 2014. Although we expect such flows to subside, as the market has already adjusted from being underweight European assets and Eurozone earnings have mostly disappointed recently, they have kept the Euro within a range at a relatively strong level for now.

    "Ccorporate flows have also been supporting the Euro since end-2012, after Mario Draghi's commitment to do whatever it takes to save the Euro and the European Central Bank (ECB)'s OMT. Our analysis suggests that European corporates were shorting the Euro as the crisis unfolded until the summer of 2012, but have been gradually buying Euros since then."

    12:15: Sterling still exposed to downside

    "Given its recent fast run, cable is still exposed to some profit taking below 1.67 in the near term, while EUR-GBP is likely to further trade close to the 0.82 area." - UniCredit Bank.

    11:25: The big picture = USD incredibly cheap

    A great note from George Saravelos at Deutsche Bank:

    "Let's forget about the next few weeks for a moment and think about the big picture. What is the market pricing for future FX rates? The chart below looks at expected currency moves over the next five years using forwards. The second chart compares 30yr forwards with PPP values, where currencies should ultimately converge over the long-run. There are two standout conclusions from this analysis.

    "The second conclusion from our analysis is that in contrast to EM, a lot of G10 FX seems exceptionally expensive versus the USD. To be sure, this is partly because US rates have sold off more than other fixed income, pushing forward points sharply wider across the board. Another part of the explanation is that G10 FX has not weakened as much as many EM currencies over the last year. Overall, G10 seems like a far more interesting valuation play versus the dollar at this stage.

    "On that basis, selling EUR/USD 30-year forwards above 2.00 (or 10-yr above 1.50) offers exceptional value."

    11:05: Corrective bias maintained

    Lloyds give us a couple of key levels to watch out for: "After making a new high early on Monday the tone has turned corrective and this bias may well continue through today if the CPI data disappoints. Initial support for GBP/USD and resistance for EUR/GBP is near current levels, but a break below 1.6680 and above 0.8210 would open potential for another 0.5% GBP decline."

    10:34: Algorithmic trading community behind GBP selling?

    "UK inflation duly comes in below expectations, though at -0.5% on the month, and 1.9% for the yearly rate, it is little reason to take a bearish view on GBP; not that this has stopped the algo community from doing just that. Cable has tested down into the mid 1.6650's, but as we mentioned earlier on, large option strikes at 1.6650 and 1.6600 lower down (for Wednesday) should help support the pair near term. EUR/GBP has tested up to .8235, but it will be interesting to see the impact of the German ZEW survey due out at 10.00 London time." - FX Market Alerts.

    10:09: A significant sterling correction could lie ahead

    Confirmation that inflation is falling will give Sterling bulls the jitters. The importance of a rate hike to current valuations can't be over-stressed, as noted by Coutts:

    "We have brought our forecast for the first UK rate rise slightly forward from the third to the second quarter of 2015. Strong growth should continue to support sterling in the near term, but if rates don’t go up in 2015 we think a significant correction would be likely."

    09:59: Euro afforded fresh support vs pound

    Commenting on the cessation of the euro's downtrend against the pound is ICN Financial:

    "The pair managed to stabilise above 0.8160 and trading positively in attempt to stabilise above the Falling Wedge support once again. The pair now finds support from Stochastic over daily basis and supports the upside move for today. The upside targets start at 0.8285 then 0.8320 and breaching the latter will be the critical upside factor for the extension of the upside move toward 0.8410 then 0.8560. Chances for upside gains remain valid as far as the pair holds above 0.8160."

    09:38: Not such good news for the pound

    "UK prices fall to their lowest level in 4 years - good news for the consumer, not such good news for the pound." - UKForex.

    09:30: Inflation falls below 2%, Sterling selling off

    This is a busy week for GBP. Today we get inflation figures.
  • Core Consumer Price Index (YoY) (Jan). Realised: 1.6% Expected: 1.9% Last Month: 1.7%
  • Consumer Price Index (YoY) (Jan) Realised: 1.9% Expected: 2% Last Month: 2%

  • The falling inflation figures will give the Bank of England plenty of breathing space when it comes to interest rate rises. Rising inflation was the one potential headache the Bank faced. Sterling is understandably selling off.

    08:58: No major sell-off expected

    Swissquote Research ahead of today's data release:

    "EURGBP sees resistance at 0.82000/100; more offers are eyed pre-21-dma (0.82472). Our closest target is placed at 0.81350/400 (down trending channel floor) then 0.808500 (January 2013 low).

    "The UK will release the January inflation figures today. The CPI y/y is expected unchanged at 2.0% (BoE’s target). Any negative surprise should give reason to Carney’s expectations of “undershooting” inflation, yet no major sell-off expected."

    08:23: Today sees the action start

    This is a busy week for GBP. Today we get inflation figures.
  • Core Consumer Price Index (YoY) (Jan). Expected: 1.9% Last Month: 1.7%
  • Consumer Price Index (YoY) (Jan) Expected: 2% Last Month: 2%

  • Importantly, with the Bank of England shifting focus away from unemployment the inflation rate will be key. The Bank simply cannot allow any upside to inflation and would have to consider cutting rates if it starts climbing. This is a sterling-positive scenario. Remember though that a strong sterling tends to cut down importation costs, and with fuel making up such a large element of the inflationary basket a high sterling allows for price rises to be kept in check.

    Monday in review - Sterling sees profit taking

  • The British pound (GBP) weakens
  • Traders cut back on exposure to GBP ahead of a busy week
  • Buy the dips argue forecasters
  • Selling EUR/GBP is a trade we like say Barclays
  • Follow yesterday's coverage here