The British pound fell below 1.2200 against the dollar while maintaining its weekly gain. Traders were analyzing the latest event. What will be the key factor in the GBP/USD movement in the end: hawkish rhetoric of the Bank of England or the banking crisis?
The pound weakened on Friday after two sessions of growth amid new reports that renewed concerns in the financial market. UBS and Credit Suisse are under scrutiny as part of a US Justice Department investigation into whether financial professionals helped Russian oligarchs avoid sanctions.
On a positive note, the BoE raised its key rate by 25 bps to 4.25% as expected. This is the highest level since 2008. In addition, the central bank will raise interest rates again if necessary, that is, if inflation remains high.
The latest data showed strong growth in UK private sector output, largely reflecting the strong performance of the service economy. The PMI survey indicated that the UK economy grew 0.2% quarter-on-quarter in the first three months of 2023.
Reaction to the central bank. What you should know
The pound's first reaction to the decision and accompanying guidance was to rise, suggesting that markets take this as a hawkish signal. The sterling jumped to seven-week highs.
The central bank said that costs and price pressures remained elevated, reflecting the unexpectedly high inflation figures released Wednesday. Indeed, the central bank seems to have had no choice but to raise interest rates and maintain a stance that continues to hinge on inflationary inputs.
Market players recall that the central bank had previously indicated a dovish pivot. In other words, a rate hike could be followed by a pause in monetary policy tightening.
Therein lies the difficulty. What will the BoE do next: the one it spoke of earlier or at the last meeting, where further rate hikes were not ruled out.
Since it is now a question of the Bank being open to further tightening, UK bond yields have been supported, as has the pound.
In addition, an additional hawkish signal came from a significant improvement in economic growth forecasts. GDP as a whole was little changed at the start of the year, but it is now expected to increase slightly in the second quarter, compared to the 0.4% decline expected in the February report.
The prospect of a multi-quarter recession - as envisioned in the August 2022 report - is not materializing. Real household disposable income may remain unchanged in the near term, when previously it was thought to have declined substantially.
It is worth noting that it was the Bank's relentlessly pessimistic forecasts that contributed to the pound's decline. The rejection of this position may provide support to the UK bond yields and the national currency.
The prospect of suspending the rate hike cycle is significant, given that expectations of a sharp decline in inflation in the coming months persist. Despite the recent surge, inflation should fall significantly in the second quarter of 2023 to a lower level than expected in the central bank's February forecast.
Expectations from the next BoE meeting
The next meeting is in May. By then another set of wage and inflation data will be released, which the market and the central bank will have to assess.
Konstantinos Venetis, Global Economist at TS Lombard says the Bank is now poised to pause given inflation will trend decisively lower.
"February's CPI report was a reminder that inflation will not fall in a straight line – it never does. But the Committee still thinks consumer price pressures remain 'likely to fall sharply over the rest of the year'. We agree," he says.
Nick Rees, FX Market Analyst at Monex Europe, says the Bank is likely signalling it has probably reached a terminal rate.
When the next inflation dataset is released on April 19 markets will pay particular attention to services CPI inflation, which was 6.6% in February. This has been one of the key indicators that core members have identified in recent communications.
It would certainly be worrying if the MPC has been spooked by just one month's data on consumer price inflation. A pause in the near term is evident and yet another 25 bps hike is fully priced into the market by June.
No further tightening is expected. However, as noted by analysts, this may not mean a pause at all, but that the risk of further rate hikes will be underestimated. The central bank may wave to raise rates further to avoid inflationary expectations taking root and CPI getting further out of control.
As for the banking crisis, some analysts expected the Bank to pause on this backdrop. But according to the statement, the BoE's Financial Policy Committee (FPC) told the MPC the UK's banking system is "resilient."
If they are not worried about problems in the banking system, it is another signal for further rate hikes if necessary. There are no factors that could stop the central bank from making another hawkish move.
Events in the labor market will be important. Signs that tighter conditions will persist will reinforce fears that underlying inflationary pressures may be more persistent.
Outlook for the pound
The pound is currently one of the best performing currencies in 2023. It looks better than some of the other currencies affected by the problems in the banking sector, thanks to the perception that UK financial services are well protected from the crisis.
The most constructive level for the GBP/USD pair is 1.2320. This is due to expectations that a rate cut is expected in the US in the second half of 2023, which means the dollar will be under pressure.
"Given the broader weakening of the dollar after the FOMC we see scope for further gains in GBP/USD over the short-term," says Derek Halpenny, Head of Research, Global Markets EMEA at MUFG Bank Ltd, in a review of the BoE's decision.
With regards to the Pound's performance over the coming week, much depends on whether the Bank hikes again. Right now the markets estimate it as 50/50.
Economists of ING expect that the pound will soon test the levels of 1.2420 and 1.2500. Thus they think that the May pause is quite probable, despite the jump in inflation.
The BoE does not play the main role in price formation. The pound will recover because of increased risks of the dollar decline.
Meanwhile, "a potential move to the 1.2400 region in GBP/USD seems to have lost some traction as of late," note Economist Lee Sue Ann and Markets Strategist Quek Ser Leang at UOB Group. "GBP is more likely to trade in a range, expected to be between 1.2230 and 1.2330."
"While GBP strength is still intact, short-term upward momentum is beginning to wane, and this combined with overbought conditions suggests 1.2400 may be out of reach this time around. However, only a breach of 1.2190 ('strong support' level previously at 1.2140) would indicate that GBP is not strengthening further."
The material has been provided by InstaForex Company - www.instaforex.comfrom Forex analysis review https://ift.tt/VJiDOLq
via IFTTT