Annual inflation in the UK accelerated to its highest level in 30 years, according to the data released this morning. The Office for National Statistics reported that the consumer price index (CPI) jumped by 6.2% in the year to February, up from 5.5% in January, while the forecast was 5.9%. Core inflation, which excludes volatile food and energy prices, rose to 5.2% in February (vs. 5% forecast) after rising by 4.4% in January. According to other articles of the report, the annual retail price index rose to 8.2% from 7.8% in January, while the producer price index rose to 14.7% in annual terms compared to 14.2% in January. (vs. 13.9% forecast).
The market reacted negatively to the news: the pound is depreciating, and the GBP/USD pair is declining.
The Bank of England set its inflation target at 2%. Economists expect inflation to pick up further in the coming months as the surge in energy prices weighs on utility costs and the situation in Ukraine exacerbates inflationary pressures. The UK regulator has already raised interest rates three times over the past few months to curb inflation. The central bank expects inflation to approach 8% in the second quarter and warns that it may surge even higher later this year. A further rate hike by the BoE seems inevitable. Yet, experts fear that another increase in interest rates could slow down the economic recovery by putting too much pressure on consumers, given higher utility bills and taxes. Therefore, the Bank of England may wait with further monetary tightening so as not to put pressure on businesses and consumers in the face of runaway inflation. On the other hand, this step will weigh on the pound as it will discourage investors who expected further monetary tightening.
Thus, the Bank of England is facing a serious challenge now: its further monetary policy should not affect the economic growth and recovery after severe coronavirus lockdowns.
There are two other factors that cause concern. The first one is the process of Brexit. In this regard, Northern Ireland remains the main bone of contention as it is still part of the EU customs union. This creates constant disagreements during customs checks on goods crossing the border. The original agreement stipulated that Northern Ireland would remain within the EU single market, meaning that goods could move between Northern Ireland and the Republic of Ireland without a "hard" border.
The UK demands to re-negotiate the post-Brexit deal on Northern Ireland as it disrupts trade with the rest of the country.
The lack of progress in negotiations between the EU and the UK could force the British government to invoke the so-called Article 16, which aims to take safeguard measures if the Protocol causes serious "economic, social or environmental hardship" that is likely to continue. However, there are no specific definitions of hardship. If the UK initiates Article 16, then the EU may respond with a lawsuit, which will once again aggravate trade relations between the two sides. This will negatively affect both the EU and the UK, and, accordingly, the pound.
The second negative factor for the British economy and the pound is the ongoing military conflict in Ukraine. Economists believe that this conflict will considerably slow down economic growth in the UK in the near future.
Meanwhile, the US dollar has more upside potential as market expectations regarding the Fed's key interest rate have changed.
Recent statements by Fed Chairman Jerome Powell and comments by other bank officials about the possible rate hike of 50 basis points at the next meetings are fueling investors' interest in the dollar. Supported by this rhetoric, the US dollar will gain positive momentum, especially against the EU currencies that stay vulnerable to events in Ukraine. In particular, the head of the ECB, Christine Lagarde, said earlier this week that "for geographical reasons, Europe is way more exposed to the war than the US." This applies to the UK as well.
The Fed also plans to start cutting its $9 trillion balance sheet, possibly at its next meeting in early May. In the meantime, USD remains in high demand as a safe haven asset, especially now when there is no progress in negotiations between Russian and Ukraine.
Thus, the downtrend seems more for the GBP/USD pair due to a number of fundamental factors.
Technical analysis and trading recommendations
In my previous review, I wrote that short positions remained a priority according to the main scenario. The breakout of the support area of 1.3141 - 1.3110 should have become a signal for the resumption of the bearish trend. However, the pair followed the alternative scenario. So, the following recommendations were relevant: Buy Stop at 1.3180, Stop Loss at 1.3130, Take Profit at 1.3210, 1.3275, 1.3308, 1.3365, 1.3390, 1.3430, 1.3515, 1.3580, 1.3640, 1.3700, 1.3745, 1.3832, 1.3900, 1.3970, and 1.4000. I also mentioned that in case of a breakout of the resistance level of 1.3210, the corrective growth may continue towards the resistance at 1.3308 (EM200 on the 4-hour chart). This scenario turned out to be true, except for the fact that the EMA200 on the 4-hour chart crosses 1.3297 rather than 1.3308. Two take-profit orders mentioned in my recommendation were triggered at 1.3210 and 1.3275.
Today, GBP/USD went higher again in the Asian session, reaching the resistance level of 1.3297 (EMA200 on the 4-hour chart).
However, right after the UK inflation data release (07:00 GMT), the pound depreciated, and the GBP/USD pair bounced off the resistance at 1.3297. The quote continues to fall, having reached 1.3221 by the time the article was published.
Our main scenario suggests that GBP/USD will continue to decline. The first signal to open short positions will be a breakout of the short-term support level of 1.3220 (EMA200 on the 15-minute chart) and 1.3210. This level corresponds to the 23.6% Fibonacci retracement which is a correction against the previous fall of the pair within the descending wave that was formed in July 2014 near 1.7200. Another confirming signal will be a breakout of the important support level of 1.3170 (EMA200 on the 1-hour chart and the lows of 2021).
The closest downside target is seen at 1.2865, where the lower boundaries of the descending channels are located on the daily and weekly charts. A break above this support area will intensify the downtrend in GBP/USD, sending the pair towards local lows of 1.2685 and 1.2400.
In an alternative scenario, GBP/USD may resume growth after a breakout of the resistance level of 1.3297. If the price breaks through the resistance levels of 1.3340 (EMA50 on the daily chart) and 1.3390 (EMA200 on the weekly chart), this will strengthen the upward movement. A breakout of the key resistance level of 1.3510 (EMA200 on the daily chart) may bring GBP/USD back into the bull market.
Support levels: 1.3220, 1.3210, 1.3170, 1.3000, 1.2950, 1.2865, 1.2685, 1.2400, 1.2250, 1.2085, 1.2000
Resistance levels: 1.3297, 1.3340, 1.3390, 1.3510, 1.3580, 1.3640, 1.3700, 1.3745, 1.3832, 1.3900, 1.3970, 1.4000
Trading recommendations
Sell Stop 1.3190. Stop Loss 1.3310. Take Profit 1.3170, 1.3000, 1.2950, 1.2865, 1.2685, 1.2400, 1.2250, 1.2085, 1.2000
Buy Stop 1.3310. Stop Loss 1.3190. Take Profit 1.3340, 1.3390, 1.3510, 1.3580, 1.3640, 1.3700, 1.3745, 1.3832, 1.3900, 1.3970, 1.4000