The pound is moving downward, with the psychologically significant level under threat. In the short term, the GBP/USD exchange rate should break down to 1.2000. How will this happen and why?
The pound has been feeling great lately, maybe too great. It has reached the 1.2450 mark. GBP has gained 9% since the September decline. Something went wrong, it has probably exhausted all its range of positive factors, and there are no new drivers ahead. Moreover, the dollar started to actively push down the world currencies, increasing in price by the index.
The dollar index stabilized at 104.00 on Wednesday, helped by rising Treasury bond yields. It fell about 0.6% on Tuesday after the Bank of Japan unexpectedly widened its yield curve control tolerance range by raising the upper limit of the tolerance band of the 10-year government bond yield. The decision came earlier than expected, reflecting continued pressure from central banks around the world to hike rates.
The dollar has also come under pressure due to fears of a recession in 2023.
Meanwhile, the current pullback has returned GBP/USD to 1.2100. The pound could plunge deeper if bulls fail to hold on to this level. For starters, the exchange rate will go below 1.2000, reaching 1.1900, and then with further bearish confidence, the pound risks returning to the October peak of 1.1645, according to Societe Generale analysts.
The post-September rally by the pound has coincided with a rise in global stock markets. Risk appetite, for the most part, helped the pound hit important marks. The S&P 500 index was recovering earlier, as investors were betting that the Federal Reserve is approaching a point at which it would abandon its rate hiking cycle. So from a fundamental standpoint, how global markets behave over the coming days and weeks will play an important role in determining the pound's direction.
"The dovish dissent by the BoE MPC last Thursday and pullback in equities following the ECB pegged GBP/USD back below 1.22 from a high of 1.2446. The correlation with equities and fading appeal of the dollar are helping sterling to defy weak domestic economic fundamentals. Cable must however defend the 200dm at 1.2094 to avoid a return below 1.20," says Kenneth Broux, an analyst at Societe Generale.
Analysts believe that the Bank of England's interest rate hike and policy update have played a role in the current decline. Although some disagree. However, there is evidence to suggest a dovish BoE actually acts as a support for the pound, as a lower peak in Bank Rate is consistent with a shallower recession in 2023.
Rather, the hawkish surprise from the ECB, which said more 50 bps hikes were required, spooked markets and therefore contributed to a lower pound.
"The bears will probably want to keep the pound below 1.2300 in the future. That means a lot of traders who bet on further gains in the British currency will fall into the trap, says Fawad Razaqzada," analyst at City Index.
A potential break below 1.2100 would be another important victory for the bears, who could push the rate below the 1.2000 level. Most analysts agree and see the potential for the pound to fall in the coming days and weeks.
Resistance is located at 1.2245, 1.2305 and 1.2385. Support is at 1.2110, 1.2025, 1.1970.
