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GBP/JPY Set to Extend Steep Downtrend Through this Week

© European Central Bank, reproduced under CC licensing

- GBP/JPY downtrend to extend through this week.

- Gravity draws GBP toward supports around 130 level.

- Yen to be driven by global risk appetite including Brexit.

The Pound-to-Yen rate was trading around 131.66 Tuesday after falling more than two percent so far this week and studies of the charts suggest the exchange rate will probably continue its downtrend in the coming days. 

The 4 hour chart, which we use to determine the short-term outlook including the next 5 days, shows how the pair has fallen steeply in recent months. This decline is expected to continue given the longer-term trend is down and there are no signs of this changing. 

The relative-strength-index (RSI) momentum indicator is in oversold territory, which normally suggests there is a risk the downtrend will stall or that the market will perhaps even rise. However, this is not enough alone to signal a reversal. A break below 131.50 would provide confirmation of a further extension down to a target at 130.70 at the January lows. 

Above: GBP/JPY rate at 4-hour intervals.

The daily chart, which we use to give us an indication of the outlook over the medium-term including the next month ahead, shows how the pair has been in a downtrend since the May highs and suggests this trend could still have lower to go, perhaps all the way down to the trendline at 130.000. 

The RSI indicator is converging bullishly with price, which means it is rising when price is falling. This normally indicates a pull-back will occur however, this signal has been clear on the chart for some time and the pair has ignored it so this may continue to be the case. 

Above: GBP/JPY rate at daily intervals.

The weekly chart, which we use to give us an idea of the longer-term outlook including the next few months ahead, shows the large wedge pattern the pair has been forming since the start of 2018. 

Although wedge patterns are generally considered bullish, the exchange rate is currently falling within the pattern after a false breakout at the start of the year. The downtrend is so entrenched we now expect a continuation lower to 128.000 and the bottom of the wedge in the long-term, at which point prices will probably bounce.  

Above: GBP/JPY rate shown at weekly intervals.

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The Japanese Yen: What to Watch

The Bank of Japan (BoJ) policy meeting overnight was a major event for the Yen, with the currency actually strengthening at the margin after the BoJ neglected to indicate that further policy easing is on the way.  

The BoJ kept its forward guidance the same, saying it will keep current extremely low interest rates for an extended period of time, at least through the spring of 2020. It left the cash rate at -0.1% and maintained its yield control target at 0.0%. However, the bank revised down its growth and inflation forecasts, suggesting a worsening backdrop. The core inflation forecast for  2019 was revised down to 1.0%, from  1.1% in the April forecast. GDP growth in 2019 is now seen at 0.7%. down from 0.8% previously.

The steep decline in the Pound-Yen cross was caused by the perception that there is now an increased probability of a ‘no-deal’ Brexit. This view gained traction over the weekend after Michael Gove said in an article in The Sunday Times that the government is working on the assumption of a ‘no-deal’ Brexit. 

New Prime Minister Boris Johnson was also reported as having asked the EU to drop the Irish back-stop from the withdrawal agreement - something they have repeatedly said is non-negotiable. He must have known that would be their answer. Johnson is standing by his word to deliver Brexit “by any means necessary.” The next twist in the Brexit saga could now be that Parliament attempts a vote of no confidence to bring down the government.    

“Of course, with parliament opposed to a no-deal Brexit, this would appear to make a new election a reasonably high probability, in order to break the impasse (the Conservatives have enjoyed a 10% bounce in the polls since Johnson took charge, mainly at the expense of the Brexit Party). The betting markets now place an uncomfortably high 36% chance of a no-deal Brexit at the end of October, up from 30% on Friday,” says Nick Smyth, an analyst at BNZ Bank.

Global risk trends are likely to be a driver of the Yen going forward since the currency is a safe haven that rises when investors grow fearful, such as during crises, and falls when investors are confident. Another potential driver of the Yen is the FOMC meeting on Wednesday where the Federal Reserve is expected to cut U.S. interest rates.

Current market expectations are that the Fed will deliver a rate cut of at least 0.25%. This is already priced in. There is also a non-negligible risk the Fed could cut rates by 0.50%, which would hurt the Dollar and probably support the Yen if it was to happen.

The Yen may be reaching oversold levels. USD/JPY is currently trading at 108.80, which is already very low by historical standards. Citibank says there's a risk of offsetting policy action from the BoJ if the rate falls to 105.00. The BoJ introduced ‘yield curve control’ the last time USD/JPY hit 105, which now sees the bank keep Japanese bond yields pinned to the floor. One side effect of that policy is it makes the Yen less attractive to investors.

Another key driver of global risk appetite is the Chinese PMI surveys due out Wednesday morning. These are seen as highly reliable indicators of future growth. Both the official and Caixin PMIs have fallen below 50 recently due to a slowdown in trade resulting from U.S. tariffs and although they are expected to recover slightly when data is released on Wednesday morning, any disappointment could see risk appetite turn negative and the Yen rally. 

 

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