This article was written by Michael Oyebamiji, an FX analyst with major focus on G-10 currencies.
GBP has rallied massively over the past couple of weeks against all major currencies, especially the USD, to set a new high for 2016. This is a move which could be attributed to an oversold condition which we saw in the first quarter of 2016.
However, I think it is now time to see another big drop to the downside on cable. Some of the reasons why I think this pair should drop will be highlighted below.
Firstly, major fundamental data surrounding the UK economy is now indicating contraction or a shrinking economy. Let’s take for example the Manufacturing PMI data for April. The final indicated a drop below 50.0 – this is the lowest reading since February 2013 and any figure below 50.0 is a strong indication of contraction.
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Services PMI data also dropped to 52.3, this is also the lowest level since 2013 and let’s bear in mind that the UK economy is more of a service economy with more than 75% of its revenue coming from the services industry.
One major factor which could be attributed to this negative data could be the uncertainty regarding the outcome of the upcoming UK referendum in June, next month. There are quite a lot of uncertainties regarding the future of the UK in Europe and as result of that, many businesses are putting all sorts of investments on hold until after the referendum in June. This is already having a negative impact on the UK economy as highlighted in the PMI reading. Hence, this is another reason why I think cable will continue to depreciate until after the referendum because of uncertainty and risk.
Furthermore, the Bank of England over the weekend made it clear to bank executives that in the case of a Brexit, the Bank of England will have to cut interest rates lower. This is another doveish tone which the market could start pricing in ahead of the referendum. It should be noted that some market participants are already speculating a possible rate cut in the UK because of the slowing economy and low inflation.
The last reason why I think cable should drop is based on my technical point of view. After breaking the January highs last week at 1.4692, it rallied all the way to 1.4798/1.480 to make a new 2016 high; this level is a very important resistance level which held pretty tight. Failure to close above 1.480 is an indication that cable is over-done to the upside and bears are ready to take over.