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GBP/JPY continues plunge on UK political fallout ahead of BoE, BoJ

This week promises heightened currency volatility as four major central banks – the US Federal Reserve, Swiss National Bank, Bank of England, and Bank of Japan – announce monetary policy decisions in the latter half of the week. The central bank parade begins on Wednesday with the Fed, which is widely expected to raise interest rates by 25 basis points, but GBP/JPY traders will be most concerned with both the continued fallout from the surprise UK election outcome last week as well as key policy decisions from the BoE and BoJ.

Sterling continued its plunge early on Monday after only a brief respite as UK Prime Minister Theresa May’s unexpectedly poor showing in last week’s general election has her scrambling to retain leadership and form a coalition government with Northern Ireland's Democratic Unionist Party. With only one week before formal Brexit negotiations with the European Union are scheduled to begin, the political stakes are high and market uncertainty is even higher. Although UK equities have not been markedly affected, sterling has been pounded as it takes the brunt of these worries.

In addition to the ongoing UK political turmoil, the pound and Japanese yen will be impacted by the BoE and BoJ policy decisions late in the week. It is unclear as to how the Bank of England may react, if at all, to the political uncertainty gripping the UK. Interest rates are expected to remain steady at 0.25%, but any potentially dovish remarks by the central bank referencing the current political environment could place increased pressure on sterling.

The Bank of Japan is also not expected to make any major policy changes. However, the yen’s strength within the past month may pose a strong concern to the BoJ, and the central bank could potentially subdue rumors that it intends to wind-down its stimulus program. The yen’s rise within the past month has been partly due to increased safety demand amid higher risk aversion, as well as narrowing bond yields between the US and Japan as US yields fall.

As these potentially currency-moving factors come into play, GBP/JPY has hit a new 8-week low on Monday as it extends the sharp downtrend that has been in place since the 148.00-area highs one month ago. In the process, the currency pair has approached a key support level around the 138.50 price region. If UK political turmoil persists ahead of impending Brexit negotiations and amid key central bank decisions, the GBP/JPY downtrend could likely be extended further. With any major break below the current 138.50-area support, the next major downside support targets are around 137.00 and 135.50, the latter of which marked the mid-April lows for the currency pair.

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