Pound jumps on less dovish than expected BoE minutes; GBP/JPY main beneficiary

It has all been about the Yen over the past couple of weeks. The Japanese currency has been falling viciously on the back of the Bank of Japan’s recent move to expand its asset purchases program, as well as concerns about the health of the world’s third largest economy after it slid into a technical recession in the third quarter. Things went from bad to worse yesterday after Prime Ministe Shinzo Abe called for snap elections. Overnight the Bank of Japan left its policy unchanged as expected but Governor Haruhiko Kuroda sounded a little deflated at his press conference, even admitting that the core CPI could fall below 1%. It was only in July when had said there was “no chance” for inflation to drop below this level. Given that the BoJ’s target is for inflation to reach 2% by next year, it is likely therefore than further expansion in QE may be needed at some point down the line. This should further pressurise the yen.

Meanwhile in the UK, the pound has been pounded by the Bank of England Governor Mark Carney’s dovish remarks at the Inflation Report presser last week. Earlier, it looked like the downward trend for sterling would continue for another day after data from the Office for National Statistics revealed that the wage growth in the UK continues to remain weak. According to the ONS, full time median gross pay totalled £518 a week in April. This was up just 0.1% on a year earlier, the smallest annual growth since 1997. Adding the effect of inflation to the formula, the real median earnings are now back to the 2011 levels.

But things changed somewhat dramatically after the Bank of England’s meeting minutes were released. Given the recent sharp falls in CPI, it was reasonable to expect that MPC members McCafferty and Weale would have dropped their hawkish views. But this wasn’t to be as they again voted for a 25 basis point rate rise. The market reacted immediately to price in a less dovish BoE than previously thought, causing GBP to strengthen across the board.

As a result, the GBP/JPY currency pair now looks set to resume its upward trajectory after hesitating around a key technical area for the best part of two weeks. Following the initial upsurge on the back of the BoJ decision to expand QE, price has stalled around the 183.95/184.15 area, where the 50% retracement level of the 2007-2011 bear trend meets the 127.2% Fibonacci extension of the last downswing from 180.70 – the September peak (i.e. the sell-off from point A to B on the chart). As the bids ran dry around the 183.95/184.15 area, the GBP/JPY naturally drifted lower before establishing a low around 181.10. But following three unsuccessful attempts to push it further lower, it looks like the bears may have thrown in the towel. Thus, if price manages to climb above last week’s high of 184.65 (point C) then this could give rise to fresh technical buying. As such, the bulls could push rates towards the next Fibonacci extension targets that are visible on the chart. The most important of these is perhaps the 161.8% extension of the AB downswing, at 188.55. But shorter-term speculators should also watch the extension levels of the CD leg as some traders are likely to book profit around those areas, especially as the RSI (not shown on the chart) is in the overbought territory of above 70. From a longer-term point of view, the sharp rally to point C and the very shallow retracement to point D, suggests that the bulk of the market is positioned long and that the next potential leg higher could be equally as significant as the BC swing. All that said, price is yet to establish a fresh high – it is still below last week’s peak of 184.65 – so there is a chance for another pullback. But so long as price holds below the key support area of 180.70/181.10, my near-term outlook would remain bullish. Only a daily close below this level would invalidate this bullish setup. But even then, the bears would do really well to push the GBP/JPY towards the 50-day SMA, let alone the 200.