Sterling Eyes Fresh 2012 Highs On BoE Policy, Euro Correction On Tap

Talking Points

• British Pound: BoE Halts QE, Quarterly Inflation Report In Focus
• Euro: Growth To Slow Further, ECB To Maintain Easing Cycle

British Pound: BoE Halts QE, Quarterly Inflation Report In Focus

The British Pound rallied to 1.6172 as the Bank of England maintained its current policy in May, and it seems as though the central bank is bringing its easing cycle to an end as it completes the GBP 325B in quantitative easing. As the BoE refrains from releasing a policy statement, market participants are certainty turning their attention to the meeting minutes due out on May 23, but the quarter inflation report on tap for the following week could spark fresh highs in the GBPUSD should the central bank raise its fundamental assessment for the U.K.

As BoE officials expect to see a faster recovery in the second-half of 2012, we should see the central bank adopt a hawkish tone for monetary policy, and we may see the Monetary Policy Committee start to discuss a tentative exit strategy as the stickiness in underlying price growth raises the risk for inflation. According to Credit Suisse overnight index swaps, market participants are starting to price a rate hike for the next 12-months, but we may see a growing rift within the MPC as the economy slips back into recession. Nevertheless, we will maintain a bullish outlook for the GBPUSD as the pair looks to be carving out a higher low around the 1.6100 figure, and upward trending channel from earlier this year should continue to take shape as the central bank looks to start normalizing monetary policy.

Euro: Growth To Slow Further, ECB To Maintain Easing Cycle

The Euro snapped back from 1.2922 amid the rebound in market sentiment, but the single currency remains at risk for further declines as the fundamental outlook for the region turns increasingly bleak. Indeed, the European Central Bank's monthly report instilled a weakening outlook for growth as the economy is now expected to contract 0.2% this year versus an initial forecast for a 0.1% decline in GDP, and the threat for a deeper recession may encourage the Governing Council to carry its easing cycle into the second-half of the year as the sovereign debt crisis continues to drag on the real economy. As the governments operating under the single currency continue to look for additional monetary support, we should see the bearish formation in the EURUSD continue to pan out in the days ahead, and we should see the pair give back the advance from earlier this year, which could open the door for a test of the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2630-50. However, as the relative strength index approaches oversold territory, we may see a short-term correction in the exchange rate, and we may see the euro-dollar make a run at the 38.2% Fib around 1.3100 before carving out a lower low.

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--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong