GBP/USD is sinking – today, the pair tested the 1,1300 area for the first time since 1985. Bearish traders have regained dominance in the market after a short pause and a brief upward correction. GBP/USD tested the resistance at 1.1370, the lower band of the Bollinger Bands indicator on the daily chart. A breakout below this level would send the pair towards 1.1300.
The massive downtrend has led to renewed speculation in the market that the pair would end 2022 in the 1.1000 area. Only 300 points separate GBP/USD from this level. The pait could easily cover this distance – over the past 7 weeks, it declined by almost 900 points. Some experts, such as currency strategists at MUFG, believe that the pair could even nosedive towards its all-time low at 1.0520.
However, it is too early to tell that such a colossal drop is imminent. Recent political and economic events suggest the pair could likely descend into the 1.1400-1.1000 range.
MUFG's analysts attribute the pound sterling's rapid devaluation to the UK's budget deficit. This figure is negatively impacting the performance of GBP amid high inflation and monetary tightening. However, there are other factors that are detrimental to the pound sterling as well.
This week, several key macroeconomic data were released. UK GDP edged up by 0.2% in July after declining in June. The unemployment rate decreased to 3.6%, and the average earnings index increased by 5.2% (discounting bonuses). Inflation retreated to 9.9% after peaking at 10.1% in the previous month.
These data releases were not particularly negative and did not trigger the pair's slump immediately. However, trader reaction to these reports were negative, as market players focused on the UK's weak economic growth amid high inflation and the worsening economic crisis. The political decisions by the UK's new prime minister Liz Truss is only exacerbating the fundamental picture. Earlier, Goldman Sachs analysts predicted that the UK could enter a recession at the end of 2022. They believe the economic downturn would be more severe compared to earlier outlooks amid a significant upsurge in energy prices. Natural gas prices could remain high over a long period of time, forcing UK residents to use their savings, while any fiscal support for UK households would likely fall short of earlier expectations.
The political plans of the new PM have also put pressure on GBP. During the campaign, Liz Truss promised to reduce VAT to 15% in its biggest decrease to date. Such a tax cut would cost the UK budget £3.2 billion per month or £38 billion per year. The new leader of the Conservative Party is also planning to reverse the rise in national insurance and cancel the corporate tax hike to 25% from 19%, which is planned to come in force in 2023. In addition, Liz Truss has repeatedly stated that she plans to review the mandate of the Bank of England.
Former Bank of England Deputy Governor Charlie Bean earlier stated that if Liz Truss won the race for PM, the UK could face a deeper and more prolonged recession. It remains to be seen if she will fulfil her campaign promises. Her first major policy decisions will likely come after the state funeral of the Queen Elizabeth II on September 19.
The pound sterling is losing ground due to several fundamental factors, such as the risk of stagflation, the energy crisis, and uncertainty about the possible decisions of the new prime minister. Hawkish expectations regarding further actions from the Bank of England do not provide support to the British currency. GBP/USD is in a clear downtrend, which is intensifying due to the US dollar rising against other major currencies.
However, it is quite risky to open long positions at this point. GBP/USD failed to break through the support at 1.1370, the lower band of the Bollinger Bands indicator on the daily chart, suggesting that this level would serve as temporary support for bulls. Short positions can be opened during the pair's upward corrections, with 1,1400 and 1,1370 being targets.