The Bank of England seems to purposefully like to surprise investors and managed to do so again last week, as three of the nine MPC members, including the chief economist, dissented in favor of an immediate hike. The move caught the market leaning the wrong way. A few hours before the announcement, both sterling, and the euro were sold to new lows for the year. The short-covering rally that ensued appears to have signaled the start of a broad corrective phase in the foreign exchange market.
The Federal Reserve and the European Central Bank try to prepare the market before the fact through word cues in addition to the formal forward guidance. The Bank of England is most transparent after the fact, insofar as it releases the minutes of the meeting, which offers a rationale for its actions, immediately. Other central banks wait several weeks.
The market is discounting about a 70% chance of a BOE rate hike in August, if we extrapolate from the OIS. Before the decision, the derivatives implied slightly less than a 50% chance. Sterling posted a key reversal in response and follow through buying ahead of the weekend lift it to $1.3315. That corresponds to the 20-day moving average, and the 61.8% retracement of sterling’s last leg down that began with the reversal after the ECB meeting on June 14.
The technical indicators allow for additional near-term gains. We suspect there is potential toward the high set earlier this month’s near $1.3470, ahead of which $1.3400 offers initial resistance. It seems only fitting that if a fundamental development (shift in monetary policy expectations) could spur a technical correction, that a fundamental consideration (EC criticism of the lack of UK progress toward a Brexit agreement) could stall sterling’s recovery next week.
Sterling’s recovery took the euro along for the ride. It made a marginal new low for the year before reversing higher with the pound. The euro also managed to return to its 20-day moving average (~$1.1675) ahead of the weekend. It also corresponds to the 50% retracement (~$1.1680) of the loss since the initial high posted on the ECB’s announcement on June 14. Additional resistance is seen near $1.1720, but given the technical indicators, there is little to stand in the way of a run toward $1.1800 or a bit higher. The $1.1600 area should now offer support. The euro finished May near $1.1650, and although it is little changed net-net, it has risen for three of the past four weeks.
