UK Gilt Yields suggest slow recovery in GBP/USD pair

The Ten-year Gilt yields in the UK came under pressure last week after the Bank of England (BOE) Quarterly Inflation Report (QIR) warned about a possibility of inflation falling below 1%. Moreover, the dovish inflation forecast reduced the probability of an interest rate hike at least in the next six months or so.

The ten-year Gilt yields weakened from 2.234% to the yesterday’s low of 2.077% as markets started pricing-in the disinflation. However, the yields have edged up today to 2.126% after the official data in the UK revealed that CPI ticked-up to 1.3% in October from the 1.2% reading in September.

Moreover, the inflation data came-in a week after the BOE’s warning of CPI falling below 1% in next six months. Hence the yields are erasing a part of the disinflation that was priced-in since the last week’s QIR.

Consequently, the GBP/USD pair rose 40 odd pips to 1.5670 levels, tracking a rise in the Gilt yields and a marginal weakness in the US Treasury yields.

Disinflation threat lingers

• The inflation expectations in the UK are likely to remain low due to falling energy prices, slow growth in the Eurozone and other major trading partners.

• Every major central bank ex-Federal Reserve has turned ultra-dovish off-late, leading to a sharp fall in their respective currencies. Bank of England, too, followed suit with an equally dovish QIR.

• However, the probability of BOE turning hawkish with a couple of upticks in inflation is low at the current juncture since it would push up GBP against major currencies leading to a further fall in inflation expectations.

Ten-year Gilt Yield - gains capped around 2.25%.

• The recovery in the yields has been muted today, despite an uptick in inflation, which indicates bond markets are still worried about a slump in the price pressures in the near future.

• Technically, the yields failed to rise above the strong resistance at 2.245% last week, opening doors for a re-test of 2.00% in the short-term.

GBP/USD short term range - 1.555 to 1.58

• Sharp gains in the GBP/USD pair are unlikely as the gains in the Gilt yields are likely to be capped around 2.25%.

• On the other hand, the Treasury yields are more likely to rise since the Fed is relatively hawkish when compared to the BOE.

• However, the GBP/USD pair is oversold and a technical correction coupled with a modest rise in Gilt yields could push the pair closer to 1.58 levels.

• Moreover, the surge in Gold prices witnessed in last few sessions indicates a possibility of correction in the US Dollar against other major currencies. Thus, losses in the GBP/USD pair are likely to be capped around 1.555 levels.