Following a sharp sell-off throughout the entire month of September, the GBP USD turned slightly lower for the year. This sell-off was influenced by the events in the Euro Zone and their negative effects on the U.K. economy. At a time when the U.K. was implementing severe austerity measures, the sovereign debt situation in Europe took a turn toward the worst, signaling the start of a global economic slowdown. Simply stated, the U.K.economy isn’t strong enough to continue to slash government expenses while battling the possibility of another recession.
Seizing the moment, bearish traders pounced on the British Pound while investors seeking safety flocked to the U.S. Dollar. This action triggered a huge decline in the GBP USD. Facing another recession, traders began to speculate that the time was right for the Bank of England to apply another round of quantitative easing.
While this rumor swirled throughout September, the Sterling continued its down slide. As we begin October, traders still have a little over a week to press the GPB USD lower. In what may become a “sell the rumor, buy the fact” situation, there is the possibility that speculators will get what they ask for at the October 6 Bank of England meeting. At that time and because of oversold conditions, traders should watch for a possible counter-trend reversal bottom at that time.
One problem that can surface during October is the clash between the government and the central bank. The Treasury which represents the government feels the need to continue to enforce its financial austerity mandate by cutting expenses. The central bank, however, sensing the possibility of another recession, may feel that additional stimulus is in order.
If economic growth continues to slow and inflation stabilizes then look for the Bank of England to enact another round of quantitative easing at its October 6 meeting. Should this come at a time when conditions improve somewhat in the Euro Zone then these could be two of the three ingredients this market needs to rally. The third being severely oversold technical conditions.
With no where to go with interest rates because of the all-time low 0.50 rate, the central bank has no choice but to inject stimulus into the system. Expanding its asset purchase program is probably a great idea provided inflation can be tamed. If inflation remains high then the size of the stimulus is likely to be small. If economic reports leading up to next central bank meeting indicate that inflation is likely to fall then look for the Bank of England to act aggressively.
Typically when a central bank applies stimulus, the underlying currency suffers, but in this case, if the stimulus is coincident with improving conditions in the Euro Zone and an easing of financial market risks then look for the GBP USD to rally. The rally, however, is likely to be short-lived. Although a rally can be expected in the GBP USD over the near-term, it is not likely to trigger a change in trend to up on the monthly charts until the entire European sovereign debt situation gets cleaned up. In addition, as long as the U.S.economy remains stronger than the U.K.economy, a significant rally is not likely to take place.
In summary, look for a relief rally in the GBP USD following a sharp sell-off in September. Severely oversold conditions and speculation the Bank of England may inject stimulus into the economy could be two factors that trigger a short-covering rally. Traders should continue to monitor the lingering debt situation in the Euro Zone since this issue could lead to a global economic slowdown which could dramatically affect the U.K.since it is already battling a weak economy.