The British pound is at risk of collapsing this week. Firstly, there was a change of mood in the markets due to the visit of Nancy Pelosi. Traders prefer to take refuge in defensive assets, such as the dollar, for a time of uncertainty. Secondly, the pound may not like the Bank of England's verdict. Markets will not be thrilled if the central bank raises the interest rate by 25 basis points on Thursday.
Judging by the positioning in the money market, investors are fully prepared for a 50 bps rate hike, as they are waiting for a strong reaction from the BoE to rising inflation in the UK and inflation expectations among consumers and businesses. At the same time, some reputable analytical agencies consider such confidence premature. In their opinion, a sharp tightening of monetary policy is still an open question. It is possible that the central bank will continue to move in increments of 25 bps. This, as you know, implies a risk of depreciation of the pound against both the dollar and the euro.
"The indicator of household expectations regarding inflation in 5-10 years fell again in July to 3.8% from 4% in June. Expectations for the year ahead also fell to 6% from 6.1%. The balance of data after the BoE's June meeting suggests that an increase of 25 bps is more likely than 50 bps," Pantheon Macroeconomics writes.
The BoE is closely monitoring inflation expectations, which may affect the degree of changes in interest rates.
Inflation expectations seem to have peaked, but they are still well above the central bank's 2% target. This means that most economists do not expect that the data will have an impact on the decision. The chances of an increase of 50 bps still remain.
"We expect that at the meeting on Thursday the rate will be increased by 50 bps, to 1.75%, amid increased domestic inflationary pressure," strategists at RBC Capital Markets predict.
By itself, an increase of half a percentage point may not surprise the pound, since this scenario has already been taken into account in prices. At the same time, another turn of events, namely an increase of 25 bps, will expose the pound to the risk of falling. Given the rising dollar, the fall may be more painful.
Such risks are also evident in the bank's pessimistic attitude towards the economic development of Britain. Medium-term forecasts of economic growth, as well as inflation, are declining, suggesting a slowdown in the rate hike cycle.
The Reserve Bank of Australia followed a similar path on Tuesday, sending the Australian dollar lower by a percentage.
The RBA raised interest rates in line with expectations by 50 bps, to 1.85%, but the aussie fell as there were signs of a less aggressive hike in the future.
Given the macroeconomic and political uncertainty, as well as weak forecast data for the UK, now is a completely inappropriate time for experiments in the form of a 50 bps rate hike. The reasons why the central bank will increase it by 25 bps this week are much more.
"The macroeconomic background remains difficult. Economic growth is under threat due to a sharp rise in energy prices. The opinion about a recession due to the higher cost of living and a reduction in real incomes remains a serious obstacle," Citi strategists in London comment on the situation.
Citi adheres to a bearish scenario regarding the pound this week. For the GBP/USD pair, the recommendation is to sell.
The quote reached the target at 1.2285 and found strong resistance there, bouncing off it and breaking through the intermediate support level of 1.2230.
Further, a corrective decline of the pair is expected with the 1.2100 target. Support is located at 1.2170, 1.2095, 1.2035. Resistance is at 1.2310, 1.2370, 1.2445.
The British economy will remain vulnerable in the short term, and the pound's growth is an opportunity to reduce risks. As for politics, this is a secondary influence for the pound, which is unlikely to react violently to the reshuffle of personnel and other events related to this.
A larger package of fiscal support from the new prime minister, according to analysts, will ease the heavy landing of the UK economy, but this is happening at a time when the cost of borrowing is rising.
However, not everyone is so categorical about the pound. UBS currency strategists believe that the growth of GBP/USD in the next few weeks has the potential to move towards 1.2335 and 1.2400.
Despite the correction that has occurred, the slope for the pound still remains upward. The pound needs to overcome the resistance at 1.2310 to establish itself in growth. The strengthening of the momentum should lead to further strengthening of the pound in the direction of 1.2335 and 1.2400.
