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GBP/USD: Can Inflation Reverse the GBP Pain Chain?

GBP/USD: Can Inflation Reverse the GBP Pain Chain?

2016-10-17 18:23:00
James Stanley, Currency Strategist

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Talking Points:

  • GBP/USD Technical Strategy: Longer-term price action still bearish & trading near 30-year lows.
  • With U.K. inflation set to be released tomorrow, the potential for sharp price movements is elevated.
  • GBP/USD is still trading near historically-low levels; most technical observations will be relegated to near-term analysis.
  • If you’re looking for trading ideas, check out our Trading Guides; they’re free and updated for Q4.

In our last article, we looked at the fleeting semblance of support in GBP/USD after news of a ‘Hard Brexit’ scenario began to dominate the headlines as of a few weeks ago. Before that happened, there was a legitimate case to be made for higher prices in Sterling: The currency had spent the previous three months working on a series of ‘higher-lows,’ and each time that Mr. Mark Carney of the Bank of England talked the currency lower, support came in at a slightly-higher level.

Much of this theme was buttressed by the logical assessment that inflation would likely begin to show in the U.K. after the ‘sharp repricing’ in the value of the British Pound (after the Brexit referendum). Initially after such a scenario, inflation usually begins to show up with imports, and this is pretty much just a mathematical observation: If a product is created, built, sold and exported out of the United States, a plunging British Pound means that this producer will bring back fewer US Dollars from U.K. sales if they don’t adjust their prices. And given that most businesses are driven by profit motive, these price increases usually show up pretty quickly, and here we have the initial signs of inflation.

But inflation isn’t always a direct determinant of currency prices, is it? The missing piece here are interest rates, as Central Banks will often look to raise rates in order of managing inflation, and this higher rate driving demand into the currency is what can really get that common but direct relationship between inflation, interest rates and spot prices all moving in the same direction.

And that’s where the relationship is or has broken down of recent. The Bank of England has been clear about the fact that they can go even more dovish if need-be, and this has been acting like a weight on the value of the British Pound where ‘good’ news for the currency or the economy is shrugged off while bad news is over-accentuated. So when news of a ‘Hard Brexit’ scenario began to look like a potential outcome, sellers slammed the Sterling lower and there simply haven’t been any ‘positive’ factors to give sellers a reason to cover or for buyers to enter the equation.

Should tomorrow’s U.K. inflation numbers surprise to the upside, this could possibly begin to change as markets may factor in a lower-probability of continued dovishness from the BOE in response to rising inflation. But traders are going to want to go into those data releases with a healthy amount of skepticism as most GBP charts remain considerably bearish.

For traders looking at short-side positions, potential resistance at prior price action inflection points in or around zones near 1.2250 and 1.2325 could be interesting for trend or continuation strategies. For bullish positions, traders are likely going to want to wait for prior swing resistance at 1.2335 to be taken out before looking to implement top-side approaches.

GBP/USD: Can Inflation Reverse the GBP Pain Chain?

Chart prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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