GBP/JPY Challenges Range Bound, Potential for Reversal

The GBP/JPY finds itself in a steep bearish trend as U.K. growth and European debt concerns have sunk the pound. The New Year will bring harsher austerity measures from the coalition government with the potential to derail the country’s recovery. Inflation above the BoE’s 3.0% threshold continues to keep a lid on any potential stimulus efforts from policy makers. Additionally, a weakening housing market is also adding to a dimming domestic growth picture. Indeed, property website Rightmove reported that home values declined 3.0% in December and forecasted that asking prices will drop another 5.0% in 2011. Meanwhile, continued price growth is putting pressure on the MPC to raise rates. The central bank’s Markets Director Paul Fisher in a recent newspaper interview projected that rates would “head back to a normalized position” of around 5 percent. Higher yield expectations could be a supportive factor for the pound, potentially leading to a reversal and keeping the GBP/JPY within its current range.

Levels to Watch:

-Range Top: 137.50 (Range, Pivot)

-Range Bottom: 126.50 (Range, Pivot)

Charts created using Strategy Trader– Prepared by John Rivera

Suggested Strategy

• Long: Place an entry at 126.50
• Stop: Set the stop to 125.50-100 pips in risk
• Target: The first target is 130.00 followed by the 20-Day SMA

Trading Tip – Holiday volume will most likely keep us on the sidelines for the remainder of the year and any tests of support beforehand will be scrutinized before taking a position. We have seen markets prone to spikes and sharp reversals which will make it difficult to gauge the sustainability of any reversal. The last time the pair traded below our entry was at the height of the credit crisis. Therefore, we have significant confidence in this set-up, but a heightened concern over European debt and its potential to spread beyond the Euro-Zone could see those levels threatened. Although, the range top is potentially at 137.50, there are significant barriers beforehand including our initial target of the 20-Day SMA. A longer-term declining trend line has capped the two prior advances where we are also seeing the 200-Day SMA converging at 133.99.

Event Risk for U.K. and Japan

U.K. – The upcoming economic calendar doesn’t offer any major event risk for the Pound by a combination of housing related releases could dictate short-term direction. More signs that the sector is faltering could add to prevailing bearish sentiment with evidence of stability laying the groundwork for a reversal. Meanwhile, the BoE equity withdrawal report for the third quarter will provide insight into future demand as funds taken out of home values are often used to purchase big ticket items and vacations. However, Britons continuing to plow money into their largest investment reflects a pessimistic outlook to growth.

Japan – Japanese fundamentals have little influence under normal circumstances but could see its market moving potential increase in the upcoming low volume environment. The country’s inflation report and release of the BoJ minutes will be some of the most significant events on an overall light economic calendar. Easing deflationary pressures will provide breathing room for the central bank which is under pressure to add to their stimulus efforts in an attempt to generate inflation. Policy makers have taken small steps compared to their U.S. counterpart, but the notes from their last gathering could show that more efforts are in the pipeline.