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How Real is the GBP/USD Rally?

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Top Stories

  • Chinese data prints mixed but inflation pressures remain high
  • BOE much more hawkish than expected sends pound to 1.6500
  • Nikkei up .46% Europe up 0.66%
  • Oil at $103.50/bbl
  • Gold at $1525/oz.

Overnight Eco

  • JPY Leading Indicators 99.5% vs. 99.9%
  • EUR German Final CPI m/m 0.2% vs. 0.2%
  • GBP Trade Balance -7.6B vs. -7.4B
  • GBP BOE Inflation Report signals tightening in Q3

Event Risk on Tap

  • CAD Trade Balance expected at
  • USD Trade Balance expected at
  • USD Crude Oil Inventories expected at
  • USD Federal Budget Balance expected at

Price Action

  • USD/JPY 81.00 proves resistance after Chinese data weighs on risk
  • AUD/USD holds up well but 1.0900 caps
  • GBP/USD nears 1.6500 after hawkish BOE
  • EUR/USD trades either side of 1.4400 as markets await resolution of Greece

Bank of England Governor Mervyn King surprised the currency market today by assuming a relatively hawkish stance as he signaled that the central bank may be ready to tighten monetary policy in Q3 of this year despite lackluster UK economic growth. GBP/USD surged as result of Mr. Kings comments approaching the 1.6500 level in the late morning London trade.

Issuing its quarterly inflation report, the BOE raised its inflation forecast and suggested that it may tighten monetary policy in the second half of the year. Although the central bank acknowledged the possibility that growth prospects, weighed by higher energy costs and considerable fiscal tightening "are skewed to the downside", it nevertheless stressed the idea that inflation remains well above target. The BOE said that if interest rates remain unchanged inflation will be above target for two years in a row.

Despite the present barriers to growth, the central bank was relatively sanguine about the prospect of GDP expansion going forward noting that business surveys and employment data suggest that underlying growth is stronger than the official output data. Overall the BOE Governor struck a relatively bullish tone helping to boost cable towards the key 1.6500 mark.

If the BOE becomes the second G-4 central bank to commence a tightening cycle, cable could stage a rally towards the 1.7000 figure over the next several weeks as traders begin to price in the prospect of higher UK rates. However, the BOE may be playing a very dangerous game with the UK economy. Mr. King himself acknowledged that fiscal tightening may depress UK growth going forward. Therefore a combination of fiscal and monetary tightening together could risk tipping the UK economy into a recession creating the worst of both worlds - contracting growth and high inflation. While price momentum for sterling looks positive in the near term, we remain much more cautious about its longer term prospects.

In North America today, the calendar carries the US Trade Balance data with markets anticipating an increase in deficit to -$46.8 Billion from -$45.8 Billion the period past. Chances a good that the data may miss to the downside, given the weaker manufacturing readings and higher cost of oil. However, the report is unlikely to have much impact on trade as its economic value is relatively minimal. With EZ sovereign debt problems still unresolved the EUR/USD remains chained to the 1.4400 figure while Aussie continues to trade well and could challenge the 1.0900 handle ahead of the Australian labor report due at 1:30 GMT tomorrow.

FX Upcoming

Currency GMT EST Release Expected Prior
CAD 12:30 8:30 Trade Balance 0.0B
USD 12:30 8:30 Trade Balance -45.8B
USD 14:30 10:30 Crude Oil Inventories 3.4M
USD 18:00 14:00 Federal Budget Balance -188.2B

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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