British Pound to Australian Dollar: GBP/AUD Overbought in the Short-Term

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The break-neck pace of the GBP/AUD ascent over recent weeks leaves the pair in the process of establishing a new longer-term up-trend, however, in the short-term it is overbought and overdue a downward correction.

Sterling has been climbing against the Aussie dollar since the 21st of April when a seemingly relentless sell-off finally reversed.

The GBP did most of the hard graft in the early days; a broad-based recovery in the UK currency came as markets realised they may have overdone the EU-referendum-inspired sell-off that dominated the opening months of 2016.

However, of late it is the AUD that has been the driving force with an interest rate cut and notable cut to inflation forecasts at the Reserve Bank of Australia at the start of May lighting up this market.

GBP/AUD now trades towards 1.95 and has reached an overbought level according to the RSI indicator, a signal that typically tells if a move on the charts has overextended. A reading above 70 on the RSI is considered 'overbought' and for this pair we are now witnessing 73.

This should caution traders to refrain from opening any more buy orders, as there is now too much risk the pair could correct.

The fact it is overbought, however, does not signal the up-trend has ended, just that it is due a pull-back or period of consolidation.

The young up-trend has also signalled it could be the start of a longer-term bull-trend after breaking above the March highs, and therefore completing a three monthly pivot higher. This is often a strong signal the pair could be about to reverse its medium or long-term trend.

Once the pair has exited the RSI’s overbought zone, therefore, we think it will start to rise even higher as the new up-trend continues to unfold.

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FX Themes

The Australian Dollar has weakened on deflation concerns after a surprisingly pessimistic inflation report from the Reserve Bank of Australia (RBA), which showed a substantial down-grade in inflation expectations for the pair, from 2-3% to 1-2% in 2016. This followed on from data showing inflation fell to a lower-than-expected 1.3% in Q1 from 1.7% expected and the same previously.

Low inflation expectations are expected to lead to further RBA interest rate cuts, thus weakening the Australian Dollar in the process.

As a major commodity exporter the Australian Dollar tends to gain much of its value from the current value of commodities.

The country's two chief exports are oil and iron ore. Although concerns that the recent rally in Iron Ore are unsustainable because there are solely due to prices being bid up by speculators, particularly on Chinese futures exchanges, the commodity continues to trade above 60 dollars a ton.

The outlook for other key commodities including oil and precious metals remains mixed at present, with some analysts expecting a recapitulation and other’s seeing further gains as still possible.

The pound remains in the throws of pre-referendum uncertainty.

Polls have actually shifted back to a closer race between the Remain and Leave camps after Remain started to pull-away materially last week, although Remain still lead by 3.0%:

“We note that betting market odds for the UK to leave the EU have picked up from around 28% to 33% over the past week. With the FT’s composite poll tracker putting the remain lead at just 3 points, we would not be surprised to see betting odds drift towards opinion polls in the run-up to the referendum.” Comments ING’s Viraj Patel.

Soft PMI data, showing Manufacturing fall into contraction mode at 49.2 was another notable drag on the pound. Construction and

Services both remained above 50, which denotes growth, but came out below expectations.

After hitting highs in the 1.4770s the GBP/USD pair fell back precipitously, no doubt skinning-alive many an over exuberant bull in the process. The blood-bath didn’t end until the exchange rate eventually stabilized at about 1.4500.

It seems rate hike expectations are currently back in the frame, which markets - whether correctly or incorrectly – judging the possibility of s 2016 interest hike as more plausible following a referendum win for Remain, rather than Leave. One notable detractor of this point of view is Capital Economics who expect Brexit to actually lead to a higher chance of a rate hike than a win for the Stay party.

Data Out in the Week Ahead

The most important overall release will be the minutes of the Bank of England (BOE) rate meeting on Thursday May 12. The spotlight will be on a) whether the voting has shifted and b) whether international factors remain a concern.

There are not major releases for the Aussie, although Crude Oil Inventories on Tuesday could impact as Oil is the country’s primary export. A rise in inventories would weigh on the price of oil as it would indicate a continued supply-glut, which in turn would weigh on the Australian Dollar.

China Industrial Production next weekend, could also impact as a high figure would indicate increased demand for Australian Iron Ore and other commodities used in Industry, and therefore helping the aussie higher.