GBP/USD slides as Bank of England spooks markets with surprise pause in rate hikes

The GBP is trading at a 6-month low against the USD and the EUR following the Bank of England’s decision to hold interest rates steady at 5.25% on Tuesday, 26th September.

Kit Juckes, macro strategist at Société Générale laid bare the consequences of this decision: “Sterling´s had a bad month because the UK’s had the biggest drop in peak rate expectations compared with other major economies, rate support for the currency has vanished.”

Other analysts are even more scathing; Ludovic Subran, Chief Economist at Allianz said “The UK is one of the few countries for which we really see a wage-price spiral in the making. The Bank of England’s decision to skip is not very reassuring. The pound is at risk.”

The decision to skip a rise in interest rates surprised the financial world. Even as inflation has continued to fall sharply in other developed economies, in the UK, it has remained elevated – even as the economy has begun to show signs of severe stress. Much of this is driven by labour costs, with wage growth remaining strong even while the UK’s manufacturing and services PMI show a contraction in both sectors.

So, the driving force behind the collapse in the GBP is not just the lack of support from interest rates but a real concern that the UK economy is heading for stagflation – a nightmarish scenario of economic contraction and high inflation. The long-term picture looks bleak too; Britain’s Institute for Fiscal Studies estimated on Thursday, 28th September, that there was a 90% chance that public borrowing in the UK over the next four years would be higher than forecast.

Michael Cahill, currencies strategist at Goldman Sachs has lowered his forecast for the GBP/USD, predicting a drop to 1.18 over the next three months, compared with a previous estimate of 1.24.

The USD’s safe haven status has exacerbated the GBP´s travails. Fears of a severe slowdown in global growth continue to stalk the markets and the US Dollar Index (DXY) is close to an 11-month high of 107.

On the Technical Front

Following the surprise interest rate decision by the Bank of England to keep its lending rate on hold at 5.25% last week, the GBP/USD remained firmly in bearish territory, and is down over 4% in September alone.

With the aggressive sell-off of the GBP last week, the GPB has had only a handful of green days in the last two weeks. Having fallen below the 38.2 Fibonacci retracement level on Tuesday, the price retraced above that level today, but considering the state of the British economy, this looks like a temporary bullish move.

GBP/USD Daily chart on XTB, prepared by Alison Heyerdahl

Price remains well below the 200-SMA (pink), the 50 EMA (blue), and the 100 EMA (purple), with a death-cross about to form, signifying further downside moves. The MACD remains firmly bearish, while the RSI, although it appears to have changed direction, is still below 50.

Lastly, the downward channel finds support at 1.2100, but the price will have to break through the channel resistance at 1.2450 to end the downtrend.