The Pound Could be Oversold Against the Dollar Say Contrarian Forecasters
- Written by: Will Peters
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While the mid-week release of UK labour market data was positive with wage growth picking up more than expected, the pound exchange rate complex (GBP) came under pressure following the market’s dovish take on the Bank of England Quarterly Inflation Report.
The Bank markedly revised down the near-term CPI inflation outlook; however, this was widely expected given the recent weak inflation numbers. Markets are currently pricing in the first interest rate rise in November 2015; a the hight of sterling's strength in 2014 some analysts were actually predicting the first hike to come in November of 2014.
This pushing back of expectations is the main culprit for GBP weakness.
Nevertheless, "the pound looks really vulnerable over the short run but its longer term prospects look better since its economy remains in reasonably sound shape," says Joe Manimbo at Western Union.
At the time of writing the pound to US dollar exchange rate (GBP/USD) is 0.18 pct lower on a day-to-day basis having attained 1.5683. The week's high was at 1.5941.
Please note that the above quote will be subject to a discretionary spread by your bank, it can vary wildly from the market rate. If you are looking to make international payments we suggest being quoted by an independent provider. By tapping the wholesale markets they can offer up to 5% more currency in some instances.
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Pound Dollar Oversold
Looking at the weekly GBP/USD chart we note the Relative Strength Index (RSI) is at 24.
A reading of 30 and below is considered to represent an oversold security and most readings naturally trend between the 30 and 70 reading.
Surely it is only a matter of time before the GBP sell-off slows and then retraces to overcome this state of affairs?
The problem, of course, concerns the timing of such a recovery. It would be a brave trader who puts their weight behind sterling in the current negative trend.
Has the Market Over-Reacted?
Lloyds Bank Research, in an exchange rate note to clients, tell us the GBP sell-off may be overdone:
"We view the market reaction to the QIR as exaggerated.
"The GDP projection was revised lower, however only marginally. Governor Carney’s comments were somewhat cautious regarding inflation and wage growth, and he showed no real urgency towards tightening monetary policy.
"However, we view there was little in the report that justifies pushing rate hike expectations further out. The OIS curve suggests the first rate hike is now fully priced by November 2015; which differs from the market implied rate expectation used for the Bank’s projections.
"We see potential for a turnaround in the re-pricing of rate expectations suggesting scope for a modest recovery in GBP. However, with sentiment towards GBP still, we may need a positive trigger to prompt a rebound.
GBP/USD to Head Back to 1.600?
Andy Scott, associate director at HiFX, comments on the latest catalyst for GBP weakness, the Bank of England's inflation report.
He reckons that the strength of the UK economy should ultimately support the UK currency:
“UK unemployment is continuing to fall – albeit at a slower rate. We’re now seeing average earnings heading back up after hitting a record low in August.
"Rising earnings are a good thing as far as the economy is concerned, easing downwards pressure on households’ disposable income, leading to increases in consumer spending.
"However, earnings still have to rise further before they match inflation, and that’s a core focus for the Bank of England. Today’s quarterly inflation report revealed that the Bank expects the dip in inflation to continue, maintaining their positive GDP growth outlook – however, with only a 0.1% drop in its forecast for next year to 2.9%.
“As inflation slows and global growth risks increase, there will be less pressure to raise rates even if the economy remains on its forecasted growth trajectory. Although the overall tone of the report was expected, sterling fell from its intraday highs against the dollar, and the euro by around 0.5% to 1.5870 and 1.2735 respectively.
"The upside of potential higher interest rates for the pound has been diminished by the declining trend in inflation. However, the economy still looks in good shape, especially compared to the eurozone. We maintain a favourable bias for GBP/EUR towards 1.3500 into next year and expect GBP/USD to recovery marginally back over the 1.6000 level.”
So while the pound may be oversold, a catalyst for a rebound is needed.