Welcome to Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there.
In this week’s edition, we discuss the pound’s extreme volatility amid the BoE’s intervention and government’s questionable policy response to soaring cost of living crisis in the UK.
GBP/USD reverses again
The GBP/USD continued its short-covering recovery first thing this morning with another big rally to climb above the 1.12 handle. However, it then sold off and was down by more than 170 pips from the high at the time of writing. Volatility is likely to remain elevated in this pair as market participants try and figure out what the BoE’s intervention means for sterling and other UK assets.
Sterling has been all over the place this week. Initially, it was slow to react to the Bank of England’s intervention and actually fell. But it then decided to join the rally with bond prices, as yields sold off. Today’s reversal has means it has dented the bulls’ hopes for a bigger recovery.
The BoE is pressing the brake and accelerator at the time, which is going to break something. And that something could be the pound. The BoE wants to bring yields lower by buying bonds at an “urgent pace” and on “whatever scale,” while hiking interest rates at the same time. To make matters worse, a week on from Kwasi Kwarteng’s very controversial mini-budget, there’s still no clarity if under-pressure Chancellor will make a U-turn on their tax-cutting (for the very rich) plan. It comes ahead of Saturday's changes to the price cap on energy bills, which should further squeeze the cost of living. A general election is looking increasingly likely with Labour now leading the polls.
So, uncertainty continues. For traders, the pound is a confusing arena to be in right now. If you must, trade with extreme care, and always ensure you are taking appropriate risk measures into account. Anything can happen.
As we have mentioned previously, the BoE’s objective is first and foremost to restore orderly market conditions. While the UK bond market may calm down due to the actions of the BoE, let’s not forget that this is possibly not the best news the pound needed. The supply of pounds as a result of the BoE’s intervention will increase at a time when the government has also announced a huge tax cutting bill. This will not help bring inflation down but will have the opposite impact.
Thus, the GBP/USD is not out of the woods. Now that it has reversed on the session, we may see it drop back below the 1.10 handle, especially with Fed’s hawkish rhetoric continuing. The next potential support is now the base of Thursday’s breakout at 1.0915. Lose that and the bulls will be in trouble again.
On the upside, 1.1200 handle is now very important as this is where the selling had initially started. No surprises why the cable turned lower from here after a big, short squeeze rally. However, in the event the bulls decide to buy GBP dips amid BoE’s intervention, and rates go on to break the aforementioned resistance at 1.1200 then that could pave the way for 1.15 handle. My base case scenario is we will see another dip first, which apparently has already started today.