For six trading sessions in a row the GBP/USD price moves in tight ranges and during it every time it tries to bounce up, it quickly falls back down again. As the pressure factors on the sterling pound are still strong, it is represented in the continuation of political anxiety in Britain. By comparing the Bank of England and the US Federal Reserve in the future of raising interest rates, the dollar will be the strongest. The GBP/USD pair is stable around the 1.2285 level at the time of writing the analysis.
The Bank of England’s base rate should be set at 10% given the scale of UK inflation, according to one of the major international finance houses. Research by Swiss Re, a wholesale provider of reinsurance and other insurance-based risk transfers, has found that the Bank of England is farther off the “curve” than any other global central bank.
The results come on the heels of the Bank of England’s decision to raise interest rates by another 25 basis points in June, raising the benchmark rate to 1.25%. The bank could move very slowly if it is to achieve its target of stabilizing UK inflation back to 2.0% according to Swiss Re. As such, Swiss Re sees more rallies coming from all major central banks, including the Bank of England which cannot be left behind by the likes of the US Federal Reserve.
“The most important central bank tightening cycle in decades has begun, and we expect more policy tightening this year and next,” says Jerome Hegele, chief economist at Swiss Re Group. “We believe that central banks will proceed with tightening policy even as growth slows, until there is a significant reduction in inflation momentum,” he adds. Overall, some economists have accused the BoE of being more focused on maintaining UK economic growth than containing inflation, meaning that it has not made rate hikes in increases of more than 25 basis points. The policy decision in May was notable as the bank indicated it was a reluctant parker, fearing that the economy was on the verge of faltering.
The bank seems to have realized that its primary objective is to fight inflation, even if it means the economy has stalled. Accordingly, Hegele says: “A strong new cycle of central bank tightening is needed.” “Adequate interest rate policy estimates, which quote our estimates of the Taylor rule, suggest that virtually all central banks with major advanced economies are at least 2 points below the levels of interest rates that can be guaranteed given the current economic environment,” he added.
The Taylor rule is an equation that states the central bank’s policy rate as a function of inflation and economic stagnation as the output gap or unemployment gap. In the case of the US Federal Reserve, the current environment would mean policy rates of around 7%, compared to 1.75% at present. For the Bank of England, a bank interest rate closer to 10% seems more appropriate.
The BoE will have little choice but to keep raising rates as long as the Fed continues at its current pace, which means a 50bp hike in the August policy decision is highly likely. Swiss Re explains that those central banks that are left behind risk seeing their currencies weaken, which only adds to inflationary pressures.
This is certainly the view of BoE MPC Catherine Mann who said in a recent speech that the Bank should be more active in following the Fed to defend the value of the GBP and reduce imported inflationary pressures. However, the BoE is full of policymakers who remain concerned about economic growth, and the odds of a rise of another 25 basis points in August remain high as a result. This will be a negative development for the GBP as the market is now fully priced at a 50bp move.
On the daily chart below, the price of the GBP/USD currency pair is moving in a neutral position, but the stronger tendency is still to the downside. The bears’ return towards the support level 1.2175 will restore the strength of the stronger bearish expectations towards the psychological support level 1.2000, respectively. The technical indicators will move towards strong oversold levels. In return for a breach of the current trend, the currency pair must move towards the resistance levels 1.2525 and 1.2700 as a first stage. I still prefer to sell the currency pair from every bullish level.