Pound Slammed in Asian Session, Markets Look to BoE to Restore Creditability

POUND STERLING GAME POINTS

• Balance of payments crisis gains traction as sterling attempts to test parity.
• Will the BoE step in to support GBP?
• BoE’s Tenreyro later in focus.

GBP/USD FUNDAMENTAL BACKGROUND

The British pound collapsed uncharacteristically 4.8% during Asian trading this morning, traditionally a time of low trading volume and minimal price volatility. While low trading volume (lower liquidity) may have contributed to the significant price action, the basic catalyst came from new UK Chancellor Kwasi Kwarteng’s announcement of additional tax cuts – the highest in 50 years!

Looking at the current Bank of England (BoE) monetary policy stance, the central bank is clearly keen to raise interest rates to tackle the inflation problem, but a looser fiscal stance is likely to result, which could help consumers in the short term (energy price caps). lead to rising inflationary pressures in the medium/long term as soon as fiscal support is removed. Complementing the problem is a weakening local currency, leaving inflation vulnerable to upward moves. Money market prices show sharp rise in interest rate moves from around 57 bps last week for the November session 75 bps today.

BOE INTEREST PROBabilities

Source: Refinitiv

The Chancellor’s tax cuts are being funded primarily through borrowing (selling UK government bonds known as ‘gilts’) at a time when the UK economy is in a debt crisis. While the Chancellor stated that the debt-to-GDP ratio is likely to fall, the opposite is more likely to be the case. This, coupled with the deteriorating economic growth outlook for the UK, has left global investors extremely cautious about financing the deficit by buying UK government bonds so far. Many are calling this a balance of payments crisis and BoE intervention could help quell sterling’s current risk aversion.

UK CURRENT ACCOUNT (YELLOW) VERSUS GBP/USD (GREEN)

Source: Refinitiv

Today’s price action has seen the sterling depreciate against almost every currency worldwide, indicating not only a strong dollar (Cable) but rather global concerns about the status of the UK economy. The economic calendar is relatively light today but the BoE Tenreyro is scheduled to speak later in the evening and will certainly draw more attention than usual

GBP/USD ECONOMIC CALENDAR

Source: DailyFX economic calendar

TECHNICAL ANALYSIS

GBP/USD DAY CARD

Diagram created by Warren VenketasI G

Cable has recouped some of its session losses in Asia and is now trading above price 1.1064 support level. While the Relative Strength Index (RSI) remains deep in oversold territory, without monetary and/or fiscal involvement and guidance, the sterling may not pull itself out of the current downtrend.

Important resistance levels:

Important support levels:

EUR/GBP WEEKLY CHART

Diagram created by Warren VenketasI G

The weekly EURGBP chart above reflects today’s fast sell-off shows and surpassed the September 2020 swing high. The EURGBP rally has pushed the pair into overbought territory and the presence of a long upper wick similar to that GBP/USD, could indicate a short-term pound recovery.

BULLISH IG CUSTOMER SENTIMENT

IG Client Sentiment Data (IGCS) shows how retailers are currently doing LONG on GBP/USD, with 76% of traders currently holding long positions (at the time of this writing). At DailyFX, we normally take a contrarian sentiment on the masses, but due to recent changes in long and short positioning, we opt for a short-term bullish bias.

Contact and follow Warrenon Twitter:@WVenketas