Pound Sterling Crusies Back Above Key Levels Against Euro and Dollar Aided by Increasing Rate of Inflation

The British Pound (GBP) enters mid-week trade having been the best performer amongst its G10 peers over the course of the previous 24 hours. 

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  • Pound to Euro exchange rate today:1.1553
  • Euro to Pound Sterling exchange rate today: 0.8656
  • Pound to Dollar exchange rate today: 1.3018

The best performing currency heading into the mid-week session has been the British Pound which rose for the first time in 10 trading days.  

Currency traders responded positively to the publication of the July inflation report even though CPI dropped -0.1% in July.

July inflation data showed a muted impact on headline inflation of the momentous decision to leave the EU.

The inflation rate on an annulaized basis rose by 0.6%, which was above the 0.5% expected and the 0.5% previous.

On a month-on-month basis the inflation rate showed a -0.1% fall, which was in line with estimates, and lower than the 0.2% previously.

Core CPI, which cuts out energy and food, showed a fall of -0.1%, which was below the 1.4% previous and 1.4% forecast.

Many analysts had predicted a strong rise in inflation due to the weak pound raising the cost of foriegn imports, however, this did not seem to be the case according to today's data.

The fact inflation remained muted may have increased confidence in the UK economy as high inflation would have pushed up costs for households placing extra pressures on budgets and potentially tipping the economy into recession territory.

Nevertheless, the data doesn't necessarily translate into a stronger pound going forward.

"The Bank of England has made it clear that the boost to inflation caused by a weaker currency will be temporary so while the currency responded positively to the report, it is positioning rather than true concerns about price pressure that is driving sterling higher," argues Kathy Lien, an analyst with BK Asset Management.

Producer Prices see largest gains

Factory Gate prices on the other hand rose strongle as the weak pound exerted its pressure more rapidly, by raising the cost of imported components. 

PPI input prices rose the most -  by 3.3% mom and 4.3% yoy in July, whilst output prices rose 0.3% both mom and yoy -  all were above expectations, but especially input prices. 

Consensus estimates provided by data on Investing.com foresaw a slowdown for both CPI and PPI in July compared to June, with July showing a fall of -0.1% (0.2% prev) and PPI slowing to 1.0% (1.8% prev).

Other’s note that the 12% drop in sterling on a trade weighted basis was likely to have increased the price of foreign imports driving up prices in both.

“Prices of products from cars to phones have already started creeping higher as firms pay more for imports. Producer-price figures released the same day may show any early impact on companies’ costs.” Said a report on Bloomberg.

Indeed, the Bank of England (BOE) itself, sees a probable rise in inflation to its 2.0% target much more quickly than previously expected.

Nevertheless, as pointed out by Credit Suisse’s senior investment advisor Bob Parker on Bloomberg news, inflation is not the BOE’s primary concern at the moment, maintaining growth and bank liquidity is, so a rise in inflation is not going to prompt an increase in interest rates from the BOE, as would normally be the case.

Forecast for the Pound Against the Euro

Against the euro, analysts at Lloyds are quite optimistic about how the pound will fare in the short-term.

Their analysis is based on a comparison of probable central bank policy trajectories, which they see as marginally favouring sterling as they still see a high probability that the European Central Bank (ECB) will go ahead and increase stimulus measures in September, weakening the euro in the process.

“In response to what it sees as a weaker outlook for economic growth, the Bank of England delivered a substantial easing package at its August MPC meeting.” Said the Lloyd’s note, adding, “While these policy measures, and the promise of further easing in the months ahead, argue for a weaker sterling, the strong likelihood of policy loosening from the ECB point to downside risks to the euro.”

Their rationale for expecting more easing from the ECB is based on Draghi’s forecast of how a Brexit might impact on Eurozone growth.

“Mr Draghi has indicated that the impact of the referendum result on Euro Area GDP might be a contraction of between 0.2% and 0.5% over three years. Moreover, a softer oil price assumption will also cast doubt on the expected pick in inflation. On balance, we suspect that the ECB could extend its QE programme by a further six months to September 2017.” Said Lloyds.

Overall the bank expects GBP/EUR to drift higher to 1.19 by year end and 1.27 by the end of 2017.

A technical analysis of the GBP/EUR pair shows the dominant downtrend remains intact, and therefore more likely to extend then reverse.

It is currently trading in the 1.1470s with an expectation that it will reach the next target at 1.1435 eventually.

According to an analysis by Commerzbank’s market technician Karen Jones, the down-trend in GBP/EUR is probably an Elliot Wave which began at the May highs.

Elliot wave theory is a type of cycle analysis. The theory states the market is made up waves, each one of which is comprised of five smaller component waves.

Jones argues the wave down from May is currently in its fifth component wave, and therefore the last wave in the down-cycle.

This would seem to suggest the pair might be close to bottoming, at least temporarily, however – critically - there are no signs yet from price action that this is the case.

Ideally we would want to see a something like a candlestick reversal pattern first before expecting a reversal higher.

The Demark Countdown indicator is also showing exhaustion according to Jones, and therefore also pointing to a reversal, however, once again price action remains stubbornly bearish, so we must stick with a bearish bias in our forecast.

The pair will probably continue falling, until it reaches its next target at the 1.1433 2013 lows, followed by 1.1400.A break below 1.1400 would signal a move down to 1.1350, the next target lower.

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Forecasts for the Pound Against the Dollar

Lloyds are much less bullish for the pound versus dollar pair, seeing the exchange rate not likely to appreciate during the rest of the year, with a target of 1.28 (currently at 1.2895).

“Relatively higher interest rates in the US should put further downside pressure on £/$ as the year progresses. Assuming a further decline in UK Bank Rate to 0.10% and a US rate hike in Q4, we forecast £/$ to edge lower towards 1.28 by year end. The risks to our forecasts, however, remain skewed heavily to the downside give the level of uncertainty.”

From a technical point of view, the pair has fallen close to major support at 1.2857, from the S1 monthly pivot.

This is likely to prove an obstacle to further downside, and may even supply a level where the exchange rate could reverse and rotate higher.

There is even a possibility - extrapolating into the future - that the pair is tracing out a double bottom reversal pattern, with the first trough low in July and the second forming now, and a move higher back up to the top of the range at 1.3400 forecast in the immediate future, as the pattern completes, however, this is highly speculative.

In the absence of such a reversal in price action a continuation of the down-trend is expected, with a move well below the pivot, confirming a bearish extension, with a break below the 1.2800 level, leading to amove down to 1.2700 initially.

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