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GBP/USD could drop below 1.26 if BoE is dovish

The Bank of England’s Monetary Policy Committee is almost certain to keep interest rates unchanged today despite inflation rising well above its 2% target. It will be interesting to see if there are any dissenters at the MPC, who may be concerned about inflation getting out of control. At 2.9%, the Consumer Price Index (CPI) measure of inflation is the highest it has been since June 2013. Core CPI inflation stands at a lofty 2.6% too. But the BoE is likely to once again blame the rise in inflation on transitory factors and as such keep its policy unchanged. Inflation in the UK has been driven first and foremost by the rise in the pound after the Brexit vote last June, and BoE’s subsequent decision to loosen its policy. The problem though is that the pace of wage growth has failed to keep up with price rises. Put another way, real wages have fallen and have done so for the first time in April for more than two years. The 1.2% month-over-month slump in retail sales, as reported by the ONS this morning, underscores these problems facing the UK: as prices rise and real wages fall consumers are being squeezed. This is yet another sign that the consumer boom that seemed to take place last year has well and truly come to an end.

What the BoE’s decision means for the GBP/USD is that it will probably fall unless the bank comes across more hawkish than expected. The US dollar surged last night after the Fed surprised the markets by being more hawkish than expected despite soft US economic data. If the dollar now stages a more meaningful comeback then this will bode ill for the GBP/USD.

After a volatile day yesterday, the Cable looks, on balance, to have trapped the buyers. After closing last week lower due, mainly, to the outcome of UK elections, any bullish moves in early this week was always going to be suspicious. And so it has probed (so far) as price wasn’t able to hold above the broken 1.2775 level yesterday on a closing basis. The next area of liquidity is undoubtedly below this week’s low of around 1.2640. So, price may fall into that area later on today and possibly go on to test the next key support at 1.2595, a level which was resistance prior to the breakout that ultimately failed ahead of 1.30. However a closing break above 1.2775 would put the bearish case to bed and in this case we may see the start of a move towards 1.30s again.

Source: eSignal and FOREX.com.

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