GBP/USD drops to key support before bounce

GBP/USD continued its fall early on Wednesday to hit a major support area around the 1.4250 level, before bouncing. This drop modestly extended the currency pair’s substantial retreat this week from its 50-day moving average and the 1.4500 level.

In the process, this retreat has erased much of the gains made during the upside pullback of late January and early February, and could be the precursor to a continuation of the longstanding bearish trend.

Though the minutes of January’s Federal Open Market Committee (FOMC) meeting, which are scheduled to be released on Wednesday afternoon, may provide some additional clarity as to the Federal Reserve’s monetary policy stance last month, financial and economic events since that meeting have weighed on the likelihood of a further rate hike in the near-term. Diminished expectations of such a rate hike have pressured the US dollar from the beginning of February, though the greenback has rebounded since late last week.

Perhaps even more vital to GBP/USD’s outlook than the dollar’s frequent gyrations due to Fed expectations, however, may be the persistently weakened state of the British pound. This weakness stems from an increasingly dovish Bank of England that was previously expected to begin its own monetary tightening cycle at some point following the initiation of the Fed’s rate hike in December. These expectations have since diminished dramatically, and even reversed to accommodate the potential for a rate cut, given recent concerns over weak economic growth, financial market instability, and low inflation.

As long as the Bank of England maintains a monetary policy stance that is consistently seen as even more dovish than the Fed’s, the underlying bearish trend for GBP/USD should continue. Despite the noted upside pullback in late January and early February, price action since then has leaned towards a potential resumption of the entrenched downtrend. With any sustained breakdown below 1.4250 support, the next major downside target remains at the 1.4000 psychological support objective, followed further to the downside by the 1.3600 support level, last touched in early 2009.

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