Brexit has proved a tough one for trading the pound but at least we are seeing the forex market get back to some semblance of normality as data and interest rate expectations are driving price action.

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In the UK, recession fears are easing as a slew of economic data has beaten expectations, meaning the total collapse in the pound that was predicted by some has not quite materialised. The Bank of England has already cut rates almost as far as they can go.

In the US, the Fed is making hard work of hiking again. Data has been mixed, the risks are still to the downside.

So is it time to get bullish about sterling, or do the bears still a grip?

Spectacular drop

 

The pound’s fall after the EU Referendum was spectacular.

GBPUSD plummeted 8% the day after the vote – the largest fall of any major currency since the era of free-floating currencies began in the 1970s.  Since slipping to multi-decade lows in July, sterling has since stabilised around the $1.30-1.34  range.

Price action over the last month has been data driven. GBP slipped below $1.29 on August 15th before enjoying a strong rally. We saw big leaps on August 16th, after CPI data showed inflation rising at its fastest pace since November 2014.

Sterling crept higher through to August 24th, before paring gains as the month ended. September 1st saw the pound take a leg higher on the monthly manufacturing PMI, which came in well above expectations and indicated that companies are getting back to business as usual. Further good data pushed the pound to a high on September 6th close to $1.3450.

The story since has been more downbeat, leaving the pound just above $1.30 as of September 19th. Inflation has failed to fire – the September report showed no real improvement despite the weak pound. The Bank of England did not launch further stimulus or cut rates again in September, but the rate-setting Monetary Policy Committee said it still expects another cut this year, which would mean taking the bank rate to zero. Most economists still seem to think that the Bank will take further action.

Recession fears ease

 

Looking ahead, the question for traders is whether the upbeat data narrative will continue, or if this story has a few more twists and turns. Recession fears are certainly easing, but we are a long way off knowing what the UK economy will be like in a few months’ time.

Bears hold the keys at the moment as interest rates could be cut again even if the UK avoids recession.

“Since the August Inflation Report, a number of indicators of near-term economic activity have been somewhat stronger than expected,” the MPC said in a release accompanying its monetary policy decision on September 15th. “The Committee now expect less of a slowing in UK GDP growth in the second half of 2016.”

And the BoE is cautious about over-egging the Brexit bounce pudding.

“In light of the tendency for survey indicators to overreact to unexpected events, the Committee expected some bounce-back in surveys of business and consumer sentiment following the sharp falls in the immediate aftermath of the vote to leave the European Union.”

This may explain why the pound has failed to gain any real lift from a run of decent data through August and September. Traders are still extremely nervous about the potential for the pound to slide towards the $1.20 handle predicted by many banks before the vote. A looming interest rate hike by the US Federal Reserve is another weight.

The focus is now the BoE’s November forecast round. “If, in light of that full updated assessment, the outlook at that time is judged to be broadly consistent with the August Inflation Report projections, a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of this year,” the Bank’s monetary policy summary read.

The bullish case is simply that UK interest rates may not endure another cut. Inflation could pick up fast, particularly as import prices rises. The UK economy could bounce back even more strongly than the current indicators suggest. The BoE could hike again before it cuts.The Fed may get cold feet.

It’s finely balanced. Each major data release – PMI, inflation, retail sales – is affecting sentiment.

Bulls will be waiting for the Bank of England. If the data continues to improve and expectations for another rate cut recede, their argument will have more weight.

But they’ll also be watching the Fed. Post Brexit the forex market is back to normal in many ways as currencies are buffeted by the dollar and US interest rates.

If not September, December looks a possibility for the Fed to raise rates. But if it refrains from hiking this year, we may see some softening in the dollar. Nevertheless, the Fed looks a lot, lot closer to raising rates than the BoE is. 

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