The pound is stuck at the bottom of the 36th figure against the dollar, waiting for the next information driver. That driver could be tomorrow's UK inflation report. If the main indicators come out in the red zone, the market will go back to talking about the prospects of introducing a negative rate by the Bank of England. Rumors about this have been going around for quite a long time – since the beginning of the coronavirus crisis. And although some members of the British central bank are skeptical of this idea, the idea itself (even in a hypothetical context) keeps market participants on their toes. A disastrous inflation report will put this issue back on the agenda, putting corresponding pressure on the pound.
Let me remind you that traders were disappointed in the latest data on the growth of British inflation. In particular, the overall consumer price index on a monthly basis plunged into the negative area, ending up at -0.1% with a forecast increase to 0.6%. Thus, inflation was at the level of August, when the next coronavirus restrictions were introduced in Britain. The core consumer price index came out at 1.1%, slowing for the first time after two months of growth. The indicator also fell short of the forecast values, demonstrating a decrease in price pressure.
The December figures, which will be published tomorrow, should show the opposite trend. Preliminary forecasts suggest that the overall index will leave the negative zone on a monthly basis and reach 0.3%, while on an annual basis the indicator will accelerate to 0.5%. The producer price index should also come out of the negative area (it is expected to grow to 0.6% m/m after a decline to -0.3%). The other components of the release, in particular, the producer purchase price index and the selling price index, should demonstrate similar dynamics.
As you can see, the preliminary forecasts for tomorrow's release are positive. But this is the well-known insidiousness of the situation: inflated expectations can be a disservice, literally and figuratively. In the event that the stated forecasts do not come true, the pound will be under significant pressure, especially against the background of ongoing conversations about the feasibility of introducing a negative rate. If we talk directly about the GBP/USD pair, then the 37th figure is at stake here, with the prospect of growth to annual highs (1.3725) and beyond. And vice versa – if the report turns out to be a failure, then the bears will have an excellent reason to return to the bottom of the 35th figure.
It should be noted here that the inflation release is important in itself, while in the current conditions we should consider it in the context of the prospects for easing monetary policy. In just two weeks – the Bank of England will hold its first meeting of the year on February 4. At the previous meeting, BoE Governor Andrew Bailey stressed that the issue of introducing a negative rate is still under deliberation, so it is not advisable to talk about it in a practical plane. The BoE has been studying this issue for six months – the central bank's economists interact with the country's financial institutions, modeling and analyzing the consequences of this step. First of all, possible side effects for the country's banking sector are being studied.
The central bank organized a large-scale study, in which the country's financial institutions had to express their opinion on reducing the rate to zero or below zero. The financial institutions had to send their responses to the relevant requests by mid-December. It is expected that at the February meeting, the British central bank will present the results of its research and announce a general verdict on the prospects for a rate cut in the negative area. In this context, a weak inflation release will be on the side of the GBP/USD bears, as in this case, the supporters of the dovish scenario will have additional arguments in their favor. But there is also a flip side to the coin – if tomorrow's indicators are at least at the forecast level, the bulls will strengthen their position, especially against the background of the dollar's vulnerability.
Indirect inflation indicators that were published earlier suggest that inflation is unlikely to disappoint - despite the quarantine restrictions in the UK, which were in effect in December. Therefore, in my opinion, the priority for the GBP/USD pair remains with long positions. From a technical point of view, the growth scenario also looks more likely: on the daily chart, the price is between the middle and upper lines of the Bollinger Bands indicator, as well as above all the lines of the Ichimoku indicator. The initial target of the upside movement is 1.3710, the upper Bollinger Bands line at D1. To gain a foothold within the 37th figure, buyers of GBP/USD need a sufficiently powerful informational reason (or a general large-scale weakening of the greenback), therefore, when such a goal is achieved, it is better to close long positions by taking a wait-and-see attitude.