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Pound set to move in the week ahead

The US dollar extended its pullback for a second day on Friday as US inflation and retail sales data came in lower than expected, modestly decreasing market bets on a Fed rate hike in June. At the same time, the Japanese yen extended its bounce on Friday from the previous day as an uptick in risk aversion due in part to US political turbulence boosted safe-haven demand for the yen and gold. Focus in the week ahead should shift increasingly towards the British pound as key data releases, especially concerning inflation, will take front and center in an otherwise relatively light week for major economic data.

In the run-up to these releases, the pound has remained reasonably well-supported in its recent rise against both the dollar and euro since around mid-March. Against the yen, sterling has climbed sharply in a strong breakout run since mid-April, as the yen has been pressured in recent weeks by decreasing safe-haven demand. This recent pound strength has been attributed in part to increased support for UK Prime Minister Theresa May as she leads Brexit negotiations with the European Union and prepares for an early-June snap election that her Conservative Party is very likely to win.

On Thursday, the Bank of England issued its monetary policy decision, and no change was made to interest rates or its quantitative easing policy, as widely expected. However, the central bank did allude to potentially tighter policy going forward, as well as its limited tolerance for above-target inflation. The pound dropped after this statement was issued, due in part to a lowered 2017 growth forecast, a downward-revised long-term inflation forecast, and an outlook for slowing household consumption. Also, there was still only one dissenting voter (MPC member Kristin Forbes) who voted for a rate hike. Despite these slightly more dovish aspects of the BoE meeting and statement, however, the overall message skewed towards an eventual tightening of policy, especially if inflation continues to rise at or above its recent pace.

Next Tuesday’s UK Consumer Price Index (CPI) data will be a key test as to whether inflation is continuing to trend higher. The previous two months saw higher-than-expected inflation increases of 2.3% on a year-over-year basis. If Tuesday’s CPI is seen to have increased in April at this rate or higher, a future BoE rate hike may become more likely and the pound’s prospects could be boosted. On Wednesday, key employment data will be released, including the unemployment rate, claimant count change, and perhaps most importantly, the average earnings index. This latter data point is also a key indicator of consumer inflation, and the previous month saw a higher than expected increase in this earnings index. And finally, Thursday brings UK retail sales numbers for April, which will be watched closely, as the March data was a deep disappointment at -1.8%.

Ahead of these key data releases next week, GBP/JPY has taken a breather in its sharp rise since mid-April. This pullback has been driven in part by a yen rebound in the past two days as risk concerns and market volatility have risen modestly from their prolonged lows. Earlier this past week, GBP/JPY hit a year-to-date high at major resistance around the key 148.00 level, retesting December’s highs, before pulling back towards the end of this week. The pullback has been relatively shallow thus far, and strong support currently resides immediately to the downside around the 145.00 level. Depending on next week’s economic data results, if 145.00 is able to hold, an upside breakout above 148.00 resistance could potentially be imminent. In that event, the next major upside target is around the 152.00 level.

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