GBP/USD's BoE-driven short squeeze could soon reverse course

While the Bank of England (BoE) unexpectedly opted for inaction on Thursday, refraining from cutting interest rates and declining to implement other stimulus measures, the central bank did state that “most members of the committee expect monetary policy to be loosened in August.” Though this was far from a promise, the statement did serve to indicate that the BoE does indeed have intentions to ease policy at its next available opportunity.

Immediately after the monetary policy summary, sterling made an unsurprising knee-jerk reaction by surging rapidly against its major counterparts, including the US dollar, euro, and yen. This reaction was largely due to a short squeeze in a sterling market that has been heavily bearish since June’s Brexit vote.

Also on Thursday, US economic data was released that provided better-than expected indications of the US economy, further reinforcing last week’s highly-positive non-farm payrolls employment numbers. The producer price index, a leading indicator of inflation, came out at its highest increase in a year at +0.5% for June against prior expectations of +0.3%. In addition, weekly unemployment claims again came in better-than-expected at 254,000 claims vs. the 263,000 anticipated. When such positive numbers are coupled with a US stock market that has been rallying to record highs and fading concerns over Brexit consequences, it seems that another interest rate hike by the Federal Reserve may perhaps be closer than previously thought.

If the Bank of England is giving strong indications of monetary policy easing next month and the Federal Reserve continues to be provided with evidence of an improving economy and rising inflation to support a near-term interest rate hike, conditions could soon be ripe for a further continuation of pressure on GBP/USD. Although the knee-jerk rise for sterling on Thursday was reasonable considering the BoE’s inaction, the prospect of a near future UK rate cut coupled with an increasing foundation for a Fed rate hike could easily push GBP/USD back on its downward spiral.

Thursday’s surge brought the currency pair back up to approach key resistance around the 1.3500 level before quickly paring its gains. If price is able to stay below 1.3500, it would be a strong bearish indication, in which case all eyes should revert back to the 1.3000 psychological support level. Any sustained breakdown below 1.3000 could put GBP/USD on track once again to begin targeting significantly further downside around the 1.2500 objective.

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