When assessing the GBP, especially against its key rivals the USD and EUR, we can take away that it is not dealing with the same type of sovereign debt concerns as we see in the Euro-zone or the US. The Cameron government took on bold austerity measures that have helped keep the UK’s AAA credit rating stable among all the rating agencies.
That is a plus in this current environment, and the GBP can be seen as an alternative to the EUR and USD. However, to start the week, the GBP/USD after gapping higher, fell back down amid a general risk-off environment and remains in its sideways range from last week.
This week is important as we have continued risk off environment amid equities sell-off, which has stalled out the most recent rally attempt by the GBP/USD.
We are going through very sideways price action.
A further decline can open up a break down through support at 1.6225. We would need to have UK fundamentals come under scrutiny or risk-off selling to extend.
On the other hand, some positive fundamentals from the UK can help boost the GBP/USD to the top of its recent range.
In order to figure out which way we will go next it will be important to assess the downfall of austerity, which is its impact on economic growth.
Austerity Measures Help UK Avoid Problems with Credit Rating Agences For Now..
George Osborne is pretty proud of himself for his austerity measures, as it helepd the UK stay out of this recent madness with the rating agencies which has befallen both the European continent and the US.
From Bloomberg: “The government plans to eliminate Britain’s structural budget deficit by 2015. Osborne wrote in the Daily Telegraph newspaper today that the U.S. rating cut and Europe’s debt crisis are a “vindication” of his efforts and show that governments can “earn credibility.”
The U.K. has benefited from political will to cut the deficit and ignore the criticism of voters and opposition politicians. It suffered a credit-rating scare in 2009, when S&P lowered the outlook to “negative.” The outlook was restored to “stable” in October 2010 after the coalition government showed “a high degree of cohesion in putting the U.K.’s public finances onto what we view to be a more sustainable footing,” S&P said.”
UK bonds have seen steady demand and have been gaining steadily during the past 6 months, causing yields on 10-year gilts to fall. There isn’t a concern that the UK will not pay back its obligations, with the country’s credit default swaps trading about half that of France.
The Danger That Austerity Short Circuits Growth
The problem with strong austerity measures is that it can choke of a fragile recovery. The UK economy only grew 0.2% in 2Q after 0.5% increase in Q1. If things keep up like that, austerity measures wind up weakening growth to such a point that the credit rating agencies may come back and say, you know what, we may have to look at you again.
A slower growth rate would also put pressure on the BOE to stimulate the economy, though beyond another round of bond purchases the central bank has its hands tied as interest rates are already at a record low level of 0.5% and inflation remains at more than double the target rate.
Awaiting the BOE’s Economic Forecasts on Wednesday – August 10th
Key for this week therefore will be the BOE’s Inflation Report – the quarterly update from the BOE both on inflation and an update of its economic forecasts. It is set for release on Wednesday, August 10th, at 4:30AM ET or 8:30AM GMT.
This report will give us insight into the UK economy and thereby will be a critical risk event this week for the GBP.
If the BOE’s growth forecasts weaken the GBP it can slide to support from last week near 1.6225, and if we break that we open up further downside risk.
The 50% retracement of the upswing from 1.5780 and 1.6475 comes in at around 1.6125 and is a reasonable downward projection if we break last week’s lows.
To the topside, we want to closely monitor the price action at our highs from last week and from Sunday’s open – our resistance in our current sideways action. A break there would open up 1.6550.
BOE Expected to Cut Growth Forecasts, Will We Hear Anything Regarding QE?
The expectation is that the BOE will lower its growth forecasts and its findings:
From The Telegraph: “Three months ago, the Bank’s central projection was that Britain would grow by around 1.8pc during 2011, which was already a downward revision on its February forecast.
Sir Mervyn King, the Bank’s Governor, is expected to cut that figure again at his Wednesday press conference, after gross domestic product (GDP) grew just 0.2pc in the second quarter – half what the Bank had expected.
Achieving 1.8pc growth in 2011 would now require the economy to grow at a quarterly rate of more than 1pc in the second half of this year, which appears a near impossibility, according to Vicky Redwood at Capital Economics.”
We will also be watched for any clues that the BOE may try to use some stimulus measures:
From Reuters: “The Bank of England’s quarterly inflation report on Wednesday may demonstrate whether it is seriously considering further steps to support UK recovery as the economy faces more pressure from a fresh bout of market turmoil. After a weekend of frantic discussions among global financial policymakers, investors are trying to gauge if the latest ructions have made a new bout of quantitative easing by the BoE more likely.
One of the problems is that Gilt yields are already pretty low and so you don’t get much bang for the buck by buying government bonds and therefore the BOE’s options may be limited beyond keeping interest rates low well into 2012.
“The BoE’s options are restricted, though. British corporate bond and commercial paper markets are smaller than in other advanced economies, which has limited past central bank intervention there, and the BoE has strongly resisted calls to extend its 2008 Special Liquidity Scheme for banks, which expires in January 2012.
…Walker also said King would have to walk a fine line. He should not appear too ready to bail out equity markets but must also avoid looking behind the curve and hampered by internal division, as the European Central Bank appears to have been last week.”
Even if King doesn’t give us clues on stimulus, the growth and inflation projections from the BOE will guide investors and traders fundamental bias for the GBP for the second half of this week.