Wednesday, May 6, 2020

Risks tilt GBP/USD to the downside; how will the BoE react at tomorrow’s monetary policy decision?

Tags
  • Dollar
  • Gold
  • Pound
  • NonFarm Payrolls
  • Bank of England

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Analysts’ Pick: Risks tilt GBP/USD to the downside; how will the BoE react at tomorrow’s monetary policy decision?

  • The BoE’s decision will probably have little influence on sterling, even though the central bank may signal a potential increase to its asset purchase program
  • The financial market is no doubt expecting a large dent to the labour market in the US, but there may still be room for the dollar to rise
  • Our outlook for the dollar is skewed towards the upside, while sterling to the downside as the UK continues to battle against the virus, will the US benefits from easing of lockdowns and recovering oil prices in the short-term.

The Covid-19 pandemic has eclipsed Brexit as the most pressing issue in the UK. As of today, the UK's death toll has surpassed that of Italy with 29,427 confirmed Covid-19 deaths and thousands more suspected. Now both the Bank of England (BoE) and the British government will have to decide on the next course of action. The BoE will meet and decide on monetary policy changes tomorrow at 2.30pm (GMT +8). A rate cut looks unlikely since the situation in the UK has not had major changes since its last meeting. The central bank instead is likely to keep rates on hold as in the March 26th monetary policy meeting. The financial market expects this, with overnight index swaps implying only a 0.1% probability for a rate cut. This signals that investors will probably be more focused on the central bank's outlook instead, tomorrow’s meeting will probably not be a strong driver for the GBP/USD currency pair.

Financial markets have not priced in any changes to the BoE’s key rate at tomorrows monetary policy decision

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The BoE may expand its asset purchase program to accommodate a possible extension to the lockdown in the UK. At the current pace of 13.5 billion pounds worth of bond purchases a week, the BoE would have used up the allotted 200 billion pounds worth of asset purchases by July. This also means that the central bank has time to delay an expansion to its next meeting in June, in which BOE Governor Andrew Bailey will more than likely signal the bank's willingness to increase asset purchases at tomorrow's press conference following the decision.

At the current pace of asset purchases the BoE will likely reach its target level by the start of July

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Sterling should see some initial downward pressure as a result of a probable expansion in quantitative easing, but the prospects of a continued lockdown in the UK will likely further dampen the outlook for pounds. Chancellor of Exchequer Rishi Sunak also now faces an issue in the government's furlough program, which is spending large amounts of cash in order to pay workers to prevent a surge in business bankruptcies. Sunak has spoken earlier this week, telling ITV News on Monday that the playout from the scheme could potentially be as much as what the government is spending on the NHS. But he has also said that the program will be stopped incrementally instead abruptly, which should relieve some pressure of the British economy.

GBP/EUR plotted against the GBP/USD suggests the recent drop may be due to the strength in the dollar

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On the side of the dollar, demand for the greenback will likely continue to increase, as oil prices start to recover and as the potential risk for an escalation in US-China relations could drive some investors back to the greenback as a form of hedge. This week's employment data also looks likely to increase demand for the dollar as unemployment will no doubt surge for the month of April, as already signalled by the spike in jobless benefit claims since March.

April’s record levels of Jobless claims benefits support forecasts for a sharp decline in employment

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Economists are forecasting private employment and nonfarm payrolls to fall by 21 million. While unlikely to impact the dollar unless there is a big discrepancy between the actual and forecasted numbers, investors will likely be more focused at the details of the report for more insight on the extent of the damage. The spread between unemployment in smaller firms and larger firms should widen more-than-expected thanks to the slow response from the US government in replenishing the small business Paycheck Protection Program.

Friday's nonfarm payrolls report likely will be the same, as the full effect of the lockdowns will be reflected in April’s report. With risks for employment likely tilted more to the downside, demand for the dollar's safe haven properties may increase as a result. More important this week however, will be any more developments on tension between the US and China, as well as a possible recovery in oil prices. With shale oil producers starting to limit their output in addition to the OPEC+ deal that has come into effect since May 1st, the pressure on oil prices has been eased. In addition, the easing of lockdowns in the US may also help to restart some demand domestically.

As a result, GBP/USD may weaken along the week, although the BoE's monetary policy decision may put some upward pressure on the currency pair tomorrow to rise towards 1.2482's level, before falling back to 1.2421's level and possible break the 1.2400 support level this week.

Technical Analysis:         

GBP/USD

Cable is trading near the bottom of its upward trendline support. This means that the bears are likely to try to retest support levels, although tomorrow’s BoE monetary policy decision could provide bulls some momentum to stop this. Our Fibonacci retracement suggests that the currency pair is still trading within the 23.6% Fibonacci retracement zone. While the bulls may get a boost from tomorrow’s BoE decision it is unlikely that they will be able to break the 23.6% Fibonacci retracement level. With risks tilted more towards the downside, the bears look more likely to dominate the currency pair in the short-term instead. As a result, we expect the bulls to put upward pressure on sterling and lift the currency pair towards 1.2482, before losing steam and allowing the bears to retest the 1.2421 and potentially the 1.2400 support levels.

Support: 1.2421 / 1.2400 / 1.2368

Resistance: 1.2482 / 1.2539 / 1.2590

GBP/USD Chart (H4)

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