The position of the pound against the dollar is deteriorating. The results of the Bank of England meeting in December, which did not favor the British pound, are still being recovered by traders. In contrast, the dollar is strengthening after a sharp decline in response to the Fed meeting's outcomes. Additionally, contradictory PMI indices and weak retail sales data were released in the UK today, and both were interpreted negatively for the pound.
The GBP/USD pair was trading around the target of 1.2450 (a semi-annual maximum) before the meeting of the English regulator. Still, today, the sellers were already at 1.2130, thanks to such a fundamental backdrop.
Given that the Bank of England raised the interest rate by 50 points yesterday to implement the baseline scenario, why are traders so pessimistic? Since there is no obvious justification, there is no market consensus on this. There are several valid arguments, which we will go over below.
Due to the outcomes of the December meeting, the English regulator raised the interest rate by 50 basis points, bringing it to 3.5% (two committee members voted against this). The Central Bank stated that although the nation is currently in a recession, "the state of the economy is slightly better than expected in November." The Central Bank predicts that after falling by 0.5% in the third quarter, UK GDP will drop by 0.1% in the fourth quarter of this year. The consumption of British households "remains weak," according to the Bank of England, and most housing market indicators "continue to deteriorate."
In a separate line, the regulator noted a slowdown in inflationary growth in light of these pessimistic assessments. Inflation is anticipated to decrease gradually in the first quarter of 2023.
Recall that the report released on Wednesday accurately captured the slowdown in British inflation. As a result, the core index decreased to 6.3% after peaking at 6.5%, and the overall consumer price index came out at 10.7% (the previous value was 11.1%, and the forecast was 10.9%).
The pound reacted negatively to the outcomes of the December meeting. In my opinion, three events led to general skepticism about the Central Bank's willingness to raise interest rates at the current pace in the first half of 2023:
- A split in the Monetary Policy Committee of the Bank of England.
- A statement of a slowdown in inflationary growth amid growing concern about the relative decline in key economic indicators.
- A statement of a slowdown in inflationary growth.
These motives are connected in some way. Numerous economists contacted by Reuters claim that the Bank of England may be the first central bank among the world's major economies to "doubt the possibility of further rate hikes, even if inflation exceeds its target level," because of the worsening of the economic crisis.
This "dovish-like" assumption has several justifications. First, two committee members (Silvana Tenreyro and Swati Dhingra) unexpectedly voted against raising the rate. They argued for maintaining the rate at three percent. Because the Committee had previously reached unanimous decisions, the expression of dissident sentiment put pressure on the British pound. Tenreyro and Dhingra made comments about their choices following the meeting. They believe that the three percent rate is "more than enough" to return inflation to the desired level and that raising the rate "for risk management reasons" is unnecessary.
Second, compared to the final communique from the Fed, the ECB, and even the SNB, the Bank of England's accompanying statement had a less authoritative tone. The English regulator overshadowed the issue of high inflation by concentrating on the negative effects of aggressive policy.
The situation for the British pound has worsened due to today's macroeconomic reports. Traders were specifically reminded of the recession when the British manufacturing PMI index fell to 44.7 points (with growth predicted to reach 47 points). Participants in the market were also disappointed by retail sales in the UK. Sales fell by 0.4% (monthly) in November, contrary to analysts' expectations of a 0.3% rise. All the report's components (including fuel costs and without them, in monthly and yearly terms) were below forecasted levels and in the red.
Thus, the pound will be compelled to follow the dollar in the medium term. It does not currently have any arguments to support its position. The Bank of England did not support the pound, and mediocre macroeconomic reports once again served as a reminder to market participants of the divisions among the Monetary Policy Committee members of the Central Bank.
Technically speaking, the GBP/USD pair is currently testing the Bollinger Bands indicator's average line on the daily chart. If the bears reach this target, the next price resistance levels will be the psychologically significant 1.2000 and 1.2050 levels (the Kijun-sen line in the same timeframe).
