Where now for GBP/USD ahead of the BoE?

With the Bank of England set to round off an incredibly sensitive week for the pound, it's time to look at GBP/USD with a view to deciphering where the market will go from here.

Bank of England
Source: Bloomberg

The Bank Of England is set to deliver its latest monetary policy decision on Thursday. With little expectation of a shift in policy, we will instead see the focus rest upon whether the markets should be bringing forward expectations for when we finally do see rates change. The past week has provided much to chew on for pound traders, with the UK election returning a weakened Tory government. Meanwhile, the deterioration in wage growth set against a spike in CPI inflation means that there is growing pressure on the BoE which continues to hold rates at rock bottom levels. Given the uncertainty of Brexit negotiations, it seems unlikely that we will see the BoE raise rates before the deal is completed in two years. For now there is more of a neutral tone to the BoE. However, given recent events, it makes sense to keep an eye out for any shift in tone within the MPC minutes.

Looking at the pound, it has performed remarkably well since the UK election, thanks in part to the weakness evident in the US dollar. However, with the election confusion came two positives for the pound. Firstly, the significant losses for the SNP have lowered the chance of a second referendum in the Scotland. Secondly, it is unlikely we will such a hard stance taken by Theresa May to Brexit negotiations from now on. The inability to gain a strong majority means that any questionable decisions taken over the Brexit will likely be shot down in parliament. This feeling that we will see a softer Brexit is helping push things along nicely this week for GBP/USD. The worry for sterling bulls is that the wider picture doesn’t look so rosy, as evident from the monthly chart below. The trend is clearly bearish, with price having rallied into a potentially important historical trendline.

On the weekly chart it doesn’t look much better, with the bullish trend of the past eight months looking like a potential retracement of the $1.3445-$1.1800 sell-off. The fact that we have seen the 76.4% Fibonacci level respected so well doesn’t exactly refute that argument. Ultimately we would need to see $1.3445 broken to rule out this bearish theory. 

Looking at the daily chart, it doesn’t look much better, with that 76.4% retracement clearly marking the top of the market in May. Looking at the trend coming into that move, we have seen two 76.4% pullbacks on the way up (circled). For that to happen once more, it would necessitate a break down to $1.2332.

Whether that happens or not, the 38.2% retracement we have seen so far seems unlikely to mark the end of this current sell-off. As such, the current rally we are seeing over the past two days is presumably going to be a short term phenomenon before we push lower once more. Given the uncertainty and confusion surrounding the UK Brexit negotiations, this doesn’t seem too much of a stretch.

Finally, the four-hour chart highlights that recent rally, with the pair moving higher at the time of writing. With that in mind, it looks like this retracement is likely to surpass the 50% we have seen so far. That leaves the 61.8-76.4% zone as a potential selling area ($1.2847-$1.2897).

Considering all this, it is clear that the short-term strength we are seeing is likely to be a short term thing, with a break above $1.2978 required to negate that short-term view. However, on the longer term it would take substantially more to view this currency pair in anything other than a bearish light.

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