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29.05.2023 01:21 PM
Pound sterling in limbo

After the publication of data on UK consumer inflation, the pound sterling did not know whether to welcome the CPI or to be discouraged. The slowdown in consumer prices was impressive: from 10.1% in March to 8.7% in April. However, Bloomberg experts predicted an even steeper decline in the annual CPI. Core inflation also disappointed. The core CPI accelerated to almost 7%, the highest level in more than 30 years. Curiously, its growth rates turned out to be approximately the same as in Argentina and South Sudan. As a result, GBP/USD continued its downward trajectory.

The dynamics of UK inflation

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Oddly, the higher supposed peak of the REPO rate and hawkish comments of the BoE's officials don't provide the sterling with support any more. So, you may wonder what is wrong with it. The situation is indeed ugly. Following the inflation data, the derivatives market raised the expected ceiling on the borrowing cost to 5.5%. In July 2022, Bank of England Deputy Governor John Cunliffe affirmed that interest rates of 5% and above are sure to entail a debt crisis for mortgage borrowers and leveraged companies.

However, Chancellor of the Exchequer Jeremy Hunt supports further tightening of monetary policy as inflation is a source of instability. It needs to be brought down. Monetary Policy Committee Member Jonathan Haskell believes that in order for high prices not to take hold at a high level, it is necessary to proceed with increases in borrowing costs.

Dynamics of market expectations for the REPO rate

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Bloomberg expects that the UK economy will face a recession in the second half of 2023. This forecast is more optimistic than the estimates of the Bank of England or the IMF. They have just said that the recession could be avoided.

The stagflation background and higher inflation than in the US and the Eurozone make the pound's position vulnerable due to lower real yields than, for example, in the United States. The European and British CPIs are roughly comparable, so the sterling and the euro are trading in sync. Both currencies are falling against the US dollar which has been extending its strength across the board. The greenback cheered the agreement between Democrats and Republicans on the national debt ceiling. This gives the Federal Reserve leverage to tighten monetary policy.

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Indeed, if at the end of April the markets were actively discussing the topic of the Fed's dovish reversal in 2023 and spoke with confidence about the end of the monetary tightening cycle, then a month later the situation changed dramatically. CME derivatives now estimate the chances of a federal funds rate hike in June at 66%. This was supported by strong data on consumer spending and the PCE price index. After them, it became clear that the US economy is on a sound footing and inflation suddenly accelerated.

Technically, GBP/USD hit the first target at 1.2355 of the earlier opened short positions. The price missed several pips until then second target at 1.23. On May, GBP/USD could create a pin bar next to the important pivot level of 1.2365. A breakout of its upper border at 1.2375 will assure traders to go long. A breakout of the lower border at 1.2335 will be the reason to open short positions.

Marek Petkovich,
Analytical expert of InstaForex
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