PMI and CPI highlighting potential GBP/USD upside

GBP/USD has punched to a new 14-month high this week, following a hawkish tone from the BoE. With this in mind, there are two main indicators you should follow as to where the pound could go next.

Source: Bloomberg

Last week saw the Bank of England (BoE) taking a more hawkish turn, after yet another rise in inflation pushed the marginal propensity to consume (MPC) closer towards enacting the first rate rise since 2007. With HSBC now expecting a rate rise in November, there is no surprise that we are seeing the pound come into favour. However, while the pathway of interest rates will concern most home owners, traders will be focusing on what this recent move will mean for the pound.

The end of the year should be a busy time from a monetary standpoint, and markets have high expectations from the BoE, European Central Bank (ECB), and the Federal Reserve (Fed). However, while it is notable that we could see all three of these central banks raise rates within a short period of time, it is clear that the timeline from the BoE is the one shifting sharply nearer. Although many see a BoE rate rise as being unlikely, given the ongoing fears over the Brexit repercussions, the fact is that we are seeing the chance of such a move rise alongside inflation. The chart below highlights the point that we typically see a close relationship between inflation and GBP/USD, with the bottom seen back in late 2015 providing the leading indication of the ultimate GBP/USD bottom seen a year ago. The rise in inflation seen this month has led to another strong move for the pound, and this chart points towards the likeliness of further upside, especially if we see the current trajectory of the consumer price index (CPI) continue apace.

The second part of the story comes with the economic prosperity of the country, as represented by the services’ purchasing managers index (PMI). The UK economy is hugely reliant upon the services sector for employment and tax revenues. Meanwhile, the PMI survey represents a leading indicator of where the sector, and thus the economy, is heading.

Looking at the graph below, it is clear that we have seen the services’ PMI lead the price over a number of years, with a typical multi-month lag between the two. What we have seen on the most recent occasion is that the sharp rise in the services PMI has not been matched by a like-for-like rally in GBP/USD. This will be thanks, in part, to the negative sentiment surrounding the pound and Brexit. However, with inflation forcing a more hawkish outlook from the BoE, we are seeing recovery in UK services finally reflected in the price. How far this rally will go remains to be seen. However, with the services PMI entering into a ten-month consolidation phase (so far), there is a good chance the current GBP/USD rally ends with a similar long-term period of consolidation.

Looking at the GBP/USD chart itself, we can see that the price has managed to break into a new 14-month high following the recent inflation data and BoE commentary, which points towards further upside. With the price pulling back, there is a chance that we could see a bounce from either the key $1.3445 or $1.3269 support levels, or a Fibonacci retracement.

The hourly chart highlights the near-term support that would be needed to bring about such a pullback, with the $1.3465 level key to seeing further downside. Should we see an hourly close below $1.3465, then the 50.00% ($1.3396), 61.80% ($1.3331), and 76.40% ($1.3263) Fibonacci support levels would come into view.

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