GBP dropped off a cliff following the Brexit referendum results but has started to stabilize in recent days. With the Conservative leadership contest winding down focus now turns to this week’s Bank of England meeting where a 0.25% rate cut is widely expected. With the pound’s plunge having already pushed a lot of stimulus into the UK economy a rate cut may already be priced in with the bigger surprise and potential for action if the central bank decides to hold off.
Through much of the Brexit campaign, GBPUSD traded in a range near $1.4000 and $1.4800. A big rally in the last week of the campaign reflected a shift in expectations to the Remain camp which then exacerbated the reaction to the vote to Leave the EU as misguided expectations had to be unwound first.
Following an initial pause near $1.3300, Cable took another dive toward $1.2700, but in recent days the pair has stabilized in the $1.2800 to $1.3000 area. On a breakdown, $1.2600 (measured move) or $1.2500 (round number) could be tested. On a breakout, $1.3200 (measured move) or $1.3315 (recent resistance and 23% Fibonacci retracement) could be tested. RSI has become oversold again, indicating the potential for a trading bounce should sentiment turn.
Thursday’s Bank of England decision may hinge on what kind of message Governor Carney wants to send to the markets. Supportive talk and readiness to step in may continue to be seen as positive by traders, but action could be seen as a negative. Recall that central bank dovishness is often seen at this point in the cycle as a sign of weakness and neutrality or hawkishness as a sign of a steady or strong economy.
For example, last week when Governor Carney removed the countercyclical buffer for banks to free up £150B in lending firepower, GBPUSD promptly fell 5 ½ cents in two days. With the pound’s plunge having pushed such a big cushion into the UK economy and the impact of Brexit on the economy still unknown, it’s questionable whether a rate cut at this time would do any more good. A cut could however, be seen as a sign of panic and potentially spark another selloff, but likely not as big a drop as previous plunges.
At this point, Cable appears to have priced in a rate cut so the downside appears limited to the recent low near $1.2785 where a retest could form a double bottom. A decision to hold off on cutting rates for now to await more information could force doves to scramble to get back on side and spark a rebound rally.