In a general environment of risk aversion today, the GBP fell against its rivals. It's interesting considering we're only a few sessions removed from traders and investors pricing in a more hawkish BOE on the back of elevated inflation readings and we had further evidence of that overnight.
When we saw producer prices showing what the Bank of England did not want to see - a surge in the core producer output rate to 0.7% in January- it was surprising to see GBP still stumble so strongly in today's session.
That tells us that the market has taken a different message from the Bank of England holding rates steady yesterday. With economic growth stumbling, and we saw more evidence of that in weak manufacturing data yesterday as well, and weak wage growth and spare capacity so high, the chances of inflation getting a firm footing are probably lower than many fear. That has been the message of BoE Governor King who has dismissed inflation risks as temporary, saying government spending cuts and slower-than-estimated economic growth will curb price pressures.
The risk for the BoE of hiking rates early will mean that bond yields would respond by soaring and that could squeeze growth prematurely. Yields have already climbed rather sharply to start the year, which has rasied funding costs across the board, but has also helped the Pound to rise from under $1.54 to over $1.63 this month.
But now, as traders anticipate next week's updated quarterly Inflation Report as well as growth figures from the BoE, they may think that the recent GBP rally has been a bit overdone and is due for a correction.
From Bloomberg: The market has fully priced in two rate hikes this year with the risk that the bank hikes sooner rather than later, but they might pause to see what effect the austerity measures have on growth, said Gavin Friend, a markets strategist at National Australia Bank in London. The market has been long sterling for a while, so it's due for a bit of a pullback, especially in light of the Bank holding yesterday.
Do we come out of this week having priced in a too hawkish BoE in which case we are seeing a corrective pull back to the rally we have seen so far this year. The move below $1.60 is an important technical sign meaning we could target the 1.58 next.
For more on this pair from the technical analysis side, see today's Technical Update: GBP/USD Expanding at Critical Support Level