GBP – No Easy Decisions for the BoE

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The first monetary policy announcement on Thursday will come from the Bank of England. After voting 5-4 to keep asset purchases unchanged, we are looking for the BoE to increase their asset purchase program by GBP50 billion to GBP375 billion. Both the U.K. and Eurozone economies have suffered a further pullback in growth since the last central bank meeting but U.K. policymakers were much closer to easing in June than ECB offficials. However like many central banks around the world, a large part of their concern was caused by the uncertainty in Eurozone but the banking union announced by EU Leaders last week neutralized a lot of the risk in the market, reducing the pressure on the BoE to ease. We still believe that the monetary policy committee will increase asset purchases and given that we share the consensus view, the greater risk for the British pound would be if the central bank left the size of their Quantitative Easing Program unchanged.

The following table shows how the U.K. economy has performed since the last monetary policy meeting. While consumer spending has been lifted by the holidays around the Queen’s Jubilee, unemployment increased, inflationary pressures declined, construction and service sector activity slowed according to the PMIs and manufacturing activity remained in contractionary levels since the last meeting. Recent data also showed net mortgage lending dropping for the first time in 15 years as cautious consumers use their discretionary income to reduce debt in case the economic outlook worsens in the coming months. The decline in price pressures is probably the most worrisome for the BoE who doesn’t want to risk inflation undershooting their target in the future.

Even if the Bank of England eases on Thursday, it won’t be their last move this year. The prospect of weaker economic activity due to slower growth in the Eurozone could still prompt further action from the BoE. An increase in asset purchases would be negative for the British pound while a surprise decision to keep purchases steady would probably lift the currency. However we don’t anticipate an exceptionally large move in the GBP/USD because if the BoE holds back tomorrow, they will still need to ease again in the next month so as they are only prolonging the pain. If they ease, any sell-off could be short-lived if investors believe that more stimulus will help to pull the U.K. economy out of recession in the long run.

Technically, the GBP/USD is currently in an uptrend according to our Double Bollinger Bands but the range is tight. If the GBP/USD sells off, the first area of support will be at the lower first standard deviation Bollinger Band. Should that level break stronger support could come in around the June low of 1.5321. On the upside the closest resistance will be where the upper second standard deviation Bollinger Band and 50 day SMA touch at 1.5766. Should that level break stronger resistance will be at the psychological significant 1.60 level.

Kathy Lien
Managing Director

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