Sterling Gilty As Charged
Jeffrey Halley | Jul 17, 2017 06:02AM ET
Sterling rallied ahead of tomorrows CPI data which will decide whether the Bank of England (BOE) breaks into a cold sweat or breathes a sigh of relief.
GBP raced skywards on Friday after US CPI disappointed at 1.6%y/y (against a consensus of 1.7%y/y) This was especially disappointing given a procession of Fed Governor’s had placed a lot of emphases on inflation with speeches from Fed Chair Yellen, Brainard, and Kaplan throughout last week, it was unsurprising to see a sharp reaction across markets. The USD sold off aggressively across the board with equities making new highs and bond yields falling. GBP also seemed to like the UK government officially acknowledged its financial obligations to the EU post-Brexit. The market thinks this will enable discussions to progress more constructively, with the second round of talks between Michel Barnier and David Davis scheduled to start today.
All this aside, judgement day for the BOE is almost certainly arriving tomorrow in the form of the U.K. CPI. Inflation has exploded higher in the U.K. following sterlings post-Brexit fall. To these wizened eyes its almost a stagflationary situation the BOE finds itself in at the moment with falling real wages (see chart below) and a rising CPI, expected at a mighty +2.90% tomorrow.
The only thing that stops me from more loudly shouting the Central Bank equivalent of mentioning Voldemort is that U.K. growth is holding up. It’s not a corner any Central Bank wants to find itself.
The BOE has already stated that it thinks inflation is transitory aka the Fed and that the country isn’t ready for a rate hike. The split on the recent MPC panel is saying something different now with some on the committee clearly reaching the point where they “blink.” I am also sure that the BoE does not want to be hiking as Brexit negotiations get under way in earnest.
Gilts
The 10-year Gilts though seem to be saying something different again. The recent price action implying the street thinks it’s when not if. Prices have fallen in recent days, and the technical picture looks very much like a bearish consolidation before falling again. (rates higher)
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Gilts are trading near the bottom of their week’s range this morning at 126.000. Support lies just below at the 125.635 level which was last weeks low. A daily close below here could imply we are about to stage a new move lower with the initial target being the Q4 2016 lows of 123.000.
Above the 10-year must overcome the 200-day moving average at 126.893 to suggest the downward move has finished.
GBP/USD
The mighty rally from Friday suggests the street regards any good news from Brexit as a reason to buy. The fact that most sterling crosses are trading near the middle of their long term ranges suggests this may be more of a dollar move then purely a UK play. I feel positioning must still be playing a part as well, with some serious long term short positioning out there. This has definitely been squeezed and to some extent reduced by Friday’s move.
The technical picture suggests though that we may still have legs to the topside. This may be reinforced by a 3.0% + CPI print tomorrow putting the dovish BoE’s strategy in danger. With the Fed on the ropes following Friday’s U.S. CPI miss, the BoE can expect no help from a resurgent dollar in the early part of the week one would think.
GBP rallied and closed above its recent medium term range high around 1.3050 on Friday. After peaking above 1.3100, it has drifted back in Asia to 1.3070 as some profit taking comes in. The next target from a technical point of view is the Fibonacci 50% retracement at 1.3335. The caveat I place here is the flash crash low is different depending on who you speak to, as there was no official low that day, just a mess. Readers should check their own charts.
Initial support sits at 1.3030, and then 1.3000 with a break suggesting a drop to the 1.2900 level could be possible.
Summary
Gilts and Sterling clearly seem to know something the Bank of England does not. To a certain extent GBP may have been supported by short covering, it is true. Nevertheless with inflation at 3.0% and Wage Growth and GDP well below 2%, the Central Bank may struggle to justify its continuing dovishness if tomorrows CPI prints North of 3.0 %. I don’t envy them.
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