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A promise to keep rates at record lows until the 7% unemployment level is met, rather than automatically hiking them up, has given Mark Carney a degree of flexibility and had the markets floundering for direction. Inflation seems very low on the priority list despite the fact that the 2% target is almost a dot in the distance.
The good news, and probably the reason why the pound has surged against all G10 currencies, is that the growth forecast has been revised higher both for this year and next.
Markets may doubt if rates will remain low until the third quarter of 2016 with the gilt yields posting new lows in the aftermath of the Carney statement. Although forward guidance was undoubtedly intended to provide reassurance and certainty, it would appear from FX and bond markets that it brought only the opposite, with an added side of volatility.
Over in Australia yesterday’s rate cut was widely expected, and was very much priced in to the foreign exchange market. In fact, the markets may well be expecting another cut by December of this year, borne out by government bond yield levels. The cost of borrowing for one year fell to a record low of 2.24% this week, while even two- and three-year yields are trading beneath the cash rate. Any further cuts will be subject to inflation levels and the current environment seems to be of little impediment to that particular action. Australia's inflation rate in the second quarter was 2.4%, well inside the central bank's desired 2% to 3% target.
Sterling has seen a 20% gain against the Aussie since the beginning of April this year, with shallow corrections not exceeding 5% rising from the low of 1.4380 to the current price level. Taking into consideration the highs of September 2008 as well as this year’s lows, we are now targeting the 23.6% retracement.
With the relative strength index (RSI) overbought on a weekly basis we could be looking at a deeper correction for the pair, particularly when taken in the context of bearish divergence on the daily RSI.