- Pound Sterling vs US Dollar recovers its highs just short of 1.2600 after comments from ECB’s Lagarde after the policy meeting.
- Lagarde said that the ECB would not be “pausing”in its tightening as inflation remained high.
- GBP/USD rallied to new highs after the Federal Reserve’s decision to lifted rates by the same amount on Wednesday.
- ECB’s accompanying statement highlighted evidence of persisting inflation pressures in the Eurozone.
The Pound Sterling (GBP) recovers year-to-date highs just short of 1.2600 against the US Dollar (USD) after hawkish comments from the President of the European Central Bank (ECB) Christine Lagarde on Thursday. After an initially bearish reaction to the ECB policy announcement the Euro – and Pound Sterling – recovered versus the US Dollar after Lagarde underscored the inflationary headwinds in the euro area during her press conference and the ECB’s determination not stop tightening monetary policy to fend off future price rises.
Friday’s Nonfarm Payrolls (NFP) jobs report, could further inject volatility into GBP/USD if it misses expectations (bearish for USD, bullish for GBP/USD) or comes out substantially higher (bullish for USD, bearish for GBP/USD).
From a technical perspective, GBP/USD continues to edge higher within a range, which is part of a broader bullish trend that began at the September 2022 lows. Longs are, therefore, favored over shorts.
GBP/USD market movers
- The European Central Bank (ECB) President, Christine Lagarde, stated the Governing Council had no plans to pause its monetary tightening given continued elevated risks to inflation, especially food inflation. She also announced the ECB was determined to reduce its APP bond holdings to zero, signalling the end of the reign of quantitative easing.
- Lagarde further stated that ECB policy was not tied to Fed policy which suggests the ECB will have no qualms about raising rates in the future even when the Fed has paused, thereby allowing the Euro to strengthen.
- The ECB announced a 25 bps rate hike after its policy meeting on Thursday. This raised the main refinancing operation rate, marginal lending facility and the deposit facility to 3.75%, 4% and 3.25%, respectively.
- The ECB accompanying policy statement began with the following words: “The inflation outlook continues to be too high for too long.” This suggests the ECB will likely continue raising rates in the future in contrast to the Federal Reserve which has probably reached peak rate.
- The Bank Lending Survey (BLS) for Q1 showed no outsized risks to Eurozone banks due to the crisis. The report did show credit conditions had tightened, however, but no more than in Q4.
- Depositors in Europe cannot facilitate withdrawals and realocations into higher-yielding money market funds or other higher-interest-bearing vehicles as easily as in the US, suggesting the systemic risk is less this side of the Atlantic.
- The Federal Reserve met market expectations for a 25 bps interest rate hike at its FOMC meeting on Wednesday, raising the Fed Funds Rate to a 5-5.25% range.
- The FOMC’s accompanying statement dropped wording that “some additional policy firming may be appropriate.”, suggesting this hiking cycle may be over and triggering a USD sell-off.
- Powell mentioned that the labor market is “very tight” and that though supply and demand in the labor market are coming to a better balance overall, labor demand is above supply – a hawkish statement.
- Powell further said that continued risks to financial stability and the effect of credit tightening did not totally rule out the need for further hikes in the future, nevertheless, he said the change in the wording of the statement was “significant”.
- Market guages of future rate hikes suggest a 95% probability of no future hikes from the Fed.
- Meanwhile, GBP is underpinned by data for March which continued to show UK inflation above 10% for the seventh consecutive month.
- This suggests the Bank of England (BoE) is far from done with hiking interest rates in the UK, and may have to hike more than once to get inflation back under control. If so, this is a medium-term bullish factor for Pound Sterling.
- Friday sees the release of April Nonfarm Payrolls, expected to show the economy added 179K new jobs. A substantially higher-than-expected result could support USD and weigh on Cable and vice versa for a lower-than-expected print.
GBP/USD technical analysis: Sideways in an uptrend
GBP/USD trades back at its highs in the upper 1.25s after the ECB meeting and press conference on Thursday. Nevertheless, the overall trend is bullish, thus, Pound Sterling longs are generally favored over shorts.
Given the dominant trend remains bullish price will probably continue breaking to fresh highs. A decisive break and close above the 1.2590 highs set on May 3, would likely lead to a continuation higher to the next key resistance level at circa 1.2680.
Decisive breaks are usually characterized by moves that begin with a strong green daily bar that breaks above the ceiling level or key high, with price closing near the highs of the day. Alternatively, three consecutive green bars above the ceiling level can also confirm breakouts. Such insignia provide confirmation that the break is not a ‘false break’ or bull trap.
The Relative Strength Index (RSI) is showing a bearish divergence with price although it is not acute enough to draw any conclusions. The RSI at the April 28 peak of 1.2583 was higher than it was at the 1.2590 May 3 peak, suggesting the most recent acsent lacked momentum. This is indicative of mild underlying weakness.
European Central Bank FAQs
What is the ECB and how does it influence the Euro?
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region.
The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa.
The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
What is Quantitative Easing (QE) and how does it affect the Euro?
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro.
QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
What is Quantitative tightening (QT) and how does it affect the Euro?
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
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Following an encouraging statement from the President of the European Central Bank, the British Pound Sterling climbed to a three week high on Wednesday.
Christine Lagarde, President of the European Central Bank, insisted that the Eurozone economy is ‘better off together’ and suggested that a Brexit deal still remains a viable possibility. The comments sent ripples through currency hedge funds, as the British Pound moved to a level not seen since June 24th against the US dollar.
The symbolic break above the 1.30 dollar level has been in short reach throughout the summer, though the Pound had been unable to clear the hurdle until this week. Analysts suggest that the positive rhetoric from Lagarde and the ECB has given a much needed push to the British currency and this has been confirmed by data that shows the Pound reaching a three week high of 1.3110 against the US Dollar.
The market saw some resistance at the 1.3110 level, suggesting that the Pound may not have much further to go before finding a resting point. This can be explained by the Bank of England’s (BoE) warning last week that Brexit is likely to have a negative effect on the British economy. This notion has been a consistent feature in the market over the past few weeks, with warning signs of a looming recession without a resolution on Brexit.
Despite the new high, the Pound is still more than 6 % lower than its pre-Brexit levels. The potential for further downside exists, depending on the outcome of Brexit talks between the UK and the EU. After the initial optimism from Lagarde’s comments, investors will be closely monitoring the Brexit discussions going forward, as the Pound will remain heavily dependent on the outcome of these talks.
In conclusion, the British Pound experienced a brief rally on Wednesday, with the currency climbing to a three week high against the US Dollar. This rally, however, is fragile and will be determined by the outcome of Brexit talks in the future. Investors will therefore need to remain cautiously optimistic and watch the news closely.