GBP/USD Faces to Face Biggest Test Yet When it Meets 1.42 Support

The GBP to USD conversion has been under notable pressure this week, but price action over the past three days has us a little more positive concerning the outlook. Is this the start of a turn-around?

The US dollar has been in driving the GBP/USD exchange rate of late with the pound showing little ability to set the agenda thanks to the dour background music that is the EU referendum.

Predictions we published at the start of the week warned that the February rally in sterling-dollar was becoming potentially over-cooked in light of the fundamental balance between the US and the UK favouring the former.

Indeed. The dollar then went on the charge coinciding with the GBP/USD's retreat from highs around 1.4550.

We have since seen dollar strength fade and the pound attempt to retake lost ground. So can those awaiting a stronger GBP/USD expect better days ahead?

Of course a lot rests with the outcome of the EU referendum negotiations due out this morning, but technically, we are note optimistic and expect rallies to be sold into.

"GBP is slightly bearish in our view against USD and will see downsides accelerate if UK retail sales data surprises to the downside.  GBPUSD’s rejection from 1.4374 overnight hints that downside bias prevails and risks a dip towards 1.4295," says a note from Hong Leong Bank in Kuala Lumpur.

Latest Pound / US Dollar Exchange Rates

	Live: 1.3335▲ + 0.06% 12 Month Best: 1.3789
*Your Bank's Retail Rate	1.2881 - 1.2935
**Independent Specialist	1.3148 - 1.3201 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

1.42 is the Big Number

As we ultimately expect sterling to continue its retreat, the obvious target is the well-established support zone at 1.42.

Rest assured speculators will have set a good number of buy orders at this level in anticipation of a bounce-back.

However, the outlook turns notably sour should 1.4200 fail.

“A break here would open the 1.4080 previous lows and then potentially the key long-term support region between 1.40 and 1.35,” say Lloyds Bank in a note to clients, "If the 1.42 region can hold, a move back through the 1.4375/1.4430 region would signal further range trading for the coming week or so, but would increase the chances of a stronger recovery towards 1.48-1.50.”

Brexit is Medium-Term Negative

You could hear talk of recent Brexit-related events as being positive, we would suggest that those watching the market take a step back and take a broader view.

ING Bank confirm the overall environment as being bearish for the pound thanks to Brexit risk:

“In our view, Brexit-related news remains an unambiguous negative in the medium-term given that markets have yet to price in the true (probability-weighted) costs of the UK leaving the EU.”

Obviously David Cameron’s negotiations in Brussels starting today may alter the impact of Brexit risk on the pound, watch for the prospect of speculative swings in the pound as rumours and counter-rumours are leaked.

Bears in the Driving Seat

In a week that we received the latest set of UK employment figures Societe General add their voice to the GBP analysis with economist Kit Juckes highlighting the growing differential between U.K and U.S wage data:

“The contrast between the drop in UK wage growth in recent months, and the acceleration in the US, is ever so striking. And not terribly sterling-friendly."

Commerzbank see GBP/USD falling to 1.3502 in the medium-term, arguing the recent bounce is now over and bears are once again back in the driving seat:

“(GBP/USD)..has at last eroded its 20 day ma to leave it back under pressure. We are viewing last week’s high of 1.4665 as the end of the correction higher."

"The interim low at 1.4151 guards the January low at 1.4083. Below it lies the minor psychological 1.4000 region. The 1.3502 January 2009 low remains our primary target medium term."

US Dollar Pushes Higher on Industrial Production and Improved Interest Rate Expectations

The big driver for the USD data-wise this week was news that Industrial production rose 0.9% m/m in January, well above consensus expectations for a 0.4% gain.

The news has seen gains by the USD against the EUR, JPY and other G10 majors.

The upside surprise in January industrial production growth was relatively broad-based across industry groups.

Manufacturing production, which accounts for three-quarters of total US industrial output, rose 0.5% m/m (forecast: 0.2%).

Motor vehicle and parts production increased 2.8% on the month.

A growing sense that the Federal Reserve would stand back from raising interest rates this year has hurt the US Dollar this February.

However, “the odds of at least one rate hike this year have shot up dramatically over the past few days, with a 34% chance of a move by December. This is a significant improvement from the mere 11% chance priced in as of last Friday,” notes Christopher Vecchio, Currency Analyst at Daily FX.

Fed Still Open to Raising Rates in 2016

The minutes of the February FOMC meeting were keenly anticipated overnight as markets were eager to get a view on how the Federal Reserve was interpreting the massive stock market sell-off that has characterised 2016 thus far.

Downgrades appear to have been the order of the day the risks to the projection for inflation were seen as weighted to the downside.

The continued slide in oil prices and the stronger US dollar were cited as being drivers for the slight cut to inflation expectations.

Furthermore, while the Fed were happy with the current employment situation they viewed the risks to its outlook for the unemployment rate as skewed to the upside.

The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff’s assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks.

But, the key takeaway is that the Federal Reserve is yet to be shaken, as was Janet Yellen when she appeared before the US Congress earlier this month.

“While acknowledging the possible adverse effects of the tightening of financial conditions that had occurred, most policymakers thought that the extent to which tighter conditions would persist and what that might imply for the outlook were unclear, and they therefore judged that it was premature to alter appreciably their assessment of the medium-term economic out-look,” says Magne Ostnore at DNB Bank in Oslo.

Outlook for the Euro Today

The impact on bank margins of a further deposit rate cut must be causing some headaches for ECB policy makers. ECB minutes released yesterday strongly hinted that the ECB is prepared to act in March and also temporarily accept an upside over-shoot in inflation.

For today, the US CPI release and news from the EU summit in Brussels will buffet the EUR via EUR/USD and EUR/GBP respectively.

"We tend to favour EUR/USD downside today, towards  the 1.1000/1050 area, on the US CPI number - but it is a low conviction call. EUR/GBP remains subject to the EU summit," says Chris Turner at ING.

After a late night, talks resume at 9CET. There is outside risk of a better deal being announced, e.g. limitations on benefits for 13 rather than 4 years,  "but any dips in EUR/GBP to the 0.7650/7700 area tentatively look a buy ahead of a difficult 4 months of campaigning," says Turner.