The Bank of England’s meeting tonight is expected to be fairly uneventful, but this isn’t going to turn the market’s focus from the sterling. Political uncertainty, a current account deficit, soft wage growth and the threat of deflation are going to keep the BoE on the sidelines for the foreseeable future, and these factors are also weighing on the pound. Since the beginning of March the sterling has fallen around 3.3% against the US dollar, despite the release of encouraging Q4 national account figures. Added to the above threats to the economy, a persistent current account deficit due to soft exports to Europe is a problem for the pound.
Nonetheless, the biggest threat comes from the general election at the beginning of next month. Current predictions suggest that no party is going to win a majority, with both Labour and the Conservatives neck and neck in the polls. Not even improving consumer confidence has been able to help the incumbent party, as it has in the past.
In the midst of all this uncertainty it’s easy to imagine a situation where the market loses interest in holding UK assets, derailing the pound. Yet, the blow would be softened by a lower pound increasing import inflation and helping to spur a recovery in overall inflation. This could result in one of two scenarios, the BoE begins to aggressively hike interest rates, threatening to choke the recovery, or it remains on hold and lets economy take off – there are of course risks with the latter scenario as well, but hyper-inflation isn’t looking like a big problem at the moment). In any event, the pound is not only looking weak, it’s needed to support the recovery effort.
The US dollar is still king
On the other side of the GBPUSD equation, there’s still uncertainty about the US economy recovery and the path of interest rates but there aren’t many options as attractive as US assets at the moment. The biggest threat to the US dollar strength story in the near-term would be a failure of the US economy to revive in spring, which would likely delay the implementation of tighter monetary policy. In the long-run, a bubble may form in the US dollar if central banks in other parts of the world begin tapering (BOJ and ECB) or tightening monetary policy (RBNZ, BOE and others), but this isn’t an issue at the moment.
Technical look: GBPAUD
GPBAUD remains in a long-term upward trend, but it’s really a battle of which currency is weaker. With the RBA’s unexpected decision to remain on hold in April, the aussie has the edge in the short-term. From a technical perspective, the pair is looking somewhat weak in the near-term, at least below 1.9500. It may make a run for trend line resistance (see chart); a break of it upward trend would expose the pair to even further downside. Above 1.9500 we’re eyeing an important psychological resistance zone around 2.0000.