GBP Drives to Highs on Hawkish BoE: USD Rip and Dip on CPI

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The British Pound is bursting higher after a Bank of England rate decision this morning. As we discussed yesterday, the prospect of a rate hike was fairly slim as this meeting did not bring updated forecasts or projections. The BoE has exhibited a pattern of only making significant changes around Super Thursday events, as we had in August. But – what we did get was a potential warning of rate hikes from the Bank, along with the expectation for October inflation to climb above 3%. The line that many are accounting for the source of this strength is where the BoE said “if the economy follows a path broadly consistent with the August inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations.’

GBP/USD Hourly: Break to Fresh Yearly High after Visiting Support Zone pre-BoE

Chart prepared by James Stanley

This is a bullish line, to be sure, but this is also something that was included in the meeting minutes at the August rate decision. We pointed this out shortly after last month’s meeting (second paragraph, first underneath the GBP/USD price chart); but in August, this was construed in a very dovish manner as the British Pound took a swan dive from prior highs that lasted for most of August. But now we’re seeing a significantly different response around the same exact warning of potential rate hikes, leading to the big question of: What’s changed?

There was another line in this morning’s statement that is new that appears to answer that question. This was the third paragraph from the bottom of the BoE’s statement accompanying this morning’s rate decision. “A majority of MPC members judge that, if the economy continues to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflation pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target. All members agree that any prospective increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.”

If we consider this statement along with the recent inflation push-points for the U.K., with Tuesday seeing 2.9% inflation for the month of August and yesterday showing wage growth of 2.1%, a rate hike appears to be on the table in the near-future for the Bank of England. The next rate decision at the BoE is a Super Thursday event in November, and this could be an opportune time to pose any policy adjustments that may be needed.

U.K. Inflation Has Been Well-Above Target for Seven Months, With No Signs of Abating

Chart prepared by James Stanley

This can also retain a bullish posture in GBP as we near that meeting. For much of the year, markets have been trying to front run the European Central Bank’s tightening of policy as growth and inflation have started to run-higher; but now we have a similar scenario in which traders may look to get in front of a potential rate hike from the BoE by getting long in anticipation of any potential move. What could populate excitement around this theme is just how strong inflation has been running in the U.K., which would make many European economies blush. The U.K. has been running inflation above the BoE’s target since February, so if the bank is looking to soften inflation, then we might be seeing more than a single 25 basis point move.

The big level to watch in GBP/USD is 1.3500. This is a major psychological level that carries some historical importance for the pair. This was the ‘Financial Collapse low’ and this held for seven years until Brexit. In the immediate aftermath of Brexit, this level became a rather consistent area/zone for resistance (up until the Bank of England’s bazooka’ of stimulus), and with this morning’s strength combined with a potential bullish engulfing pattern on the Daily chart, it seems as though a retest of this resistance/prior support may be in the cards for the near-term.

GBP/USD Daily: Fast Approaching the Vaulted 1.3500 Psychological Level (GFC Low Held for 7+ Years)

Chart prepared by James Stanley

U.S. Inflation Stronger than Expected at 1.9%, Core at 1.7%

In the final inflation print ahead of next week’s Fed meeting, prices showed a rather brisk rise, matching the print that was seen in May and getting closer to returning to that 2% marker that the Fed keeps as an inflation target. Perhaps more importantly, this continues the trend from August where the slowdown with inflation from February to May appears to have ceased, as we now have two consecutive months of higher prices.

U.S. Inflation Rises to 1.9% in August

Chart prepared by James Stanley

The Dollar posed an initial topside pop as a result of this print. However, the price action here does not appear to be like what we have in the British Pound, where significant follow-thru is continuing to show. In the U.S. Dollar, we’re already seeing an early seller response at those new weekly highs, leading to the idea that this bullish move is corrective in nature as the longer-term down-trend remains intact.

DXY Hourly: Strength from Inflation Report Quickly Faded Out of Markets, Bears Remain Vigilent

Chart prepared by James Stanley

This leaves the U.S. Dollar in a rather bearish state as we approach next week’s highly-watched Fed meeting. The FOMC could potentially roll-out balance sheet reduction at that meeting, and questions abound about what types of consequences or repercussions could be seen from there. With the S&P rallying up to a new high yesterday while both the Dow and the Nasdaq test prior highs, it would appear that the Fed has a fairly friendly backdrop to roll out potential new policies; and if they do announce the start of balance sheet reduction, we could see a continuation in the sell-off in the U.S. Dollar; as the Fed’s focus for tightening shifts to balance sheet run-off while economies in Europe and the U.K. are looking at higher rates (which could continue to attract demand from currency markets).

U.S. Dollar via ‘DXY’ Daily: 2017 Down-Trend Continues Ahead of September FOMC

Chart prepared by James Stanley

— Written by James Stanley, Strategist for DailyFX.com

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