Published On: Mon, Apr 22nd, 2013

The pound consolidates as BOE tackles buoyed inflation

The Pound has rallied off its low recently but will be tested with market resistance as investors absorb the recent inflation data and the nuances from the Bank of England’s meeting minutes.  As the calendar moves closer to the spring, volatility might rise if the past few years are any indication of choppy trading.

The UK inflation reports which included both wholesale and consumer price indices were in line with expectations.  Inflation within the UK seems to be holding steady relative to other developed countries.  CPI climbed 0.3% in March for a 2.8% pace year over year.  This compares to a decline in the US on the headline figure and an increase of .1% ex-food and energy.  The stickiness of the UK inflation levels is preventing the broad MPC from increasing the current bond purchase program.  Without additional stimulus the UK economy is likely to remain stagnant.

The minutes from the BOE’s meeting earlier this month were reported on Wednesday.  Governor King has voted with the minority which was to become more accommodative at the previous two meetings.  The April meeting minutes show that the vote for extending QE remained the same as the March meeting. Without a clear majority the BOE will not resume its Gilt purchase program.

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The 2 year yield differential between short term Gilts and short term US treasuries seems to have made a higher bottom near 1.43, compared with the low made in mid-September. As one countries yields grow relative to another’s it becomes more attractive to investors to keep capital in that yield.  To benefit for example from a higher UK yield relative to the US dollar, investors would need to purchase the GBP/USD currency pair.  The current 2-year yield level means that investors would earn approximately 1.52% if the currency remained at the current levels for a 2-year period.

The strong correlation between the GBP/USD and the 2-year yield differential remains very high near 80%, despite the recent selloff in the sterling.  With US economic data continuing to show a potential soft patch, yields in the US could continue to remain lower than UK yields.  The 10-year yield differential on a weekly basis continues to favor a bottoming of the pound versus the US dollar similar to the pattern created by the 2-year yield differential.

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The weekly GBP/USD chart shows a current pair that has broken down and is now retesting former support at 1.5370.  The rebound has generated weekly momentum which is now pointing to further upside.  The MACD (moving average convergence divergence) index is poised to generate a buy signal.  This occurs when the spread (the 12-week moving average) minus the 26-week moving average, crosses above the 9-week moving average of the spread.

The rebound on a weekly basis can continue to move higher, as the RSI (relative strength index) is printing near 43 which is near the bottom of the neutral range.  The print is still above the 30 trigger level for an oversold condition.  Look for further US data to continue to drive the GBP/USD currency pair.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.