The pound has started the new week how it ended the last one: lower. It fell below the $1.34 handle for the first time since December earlier this morning before bouncing back slightly ahead of Brexit talks and publication of UK inflation data later in the week. But with sentiment being extremely negative towards the pound, we think that the probability of it going significantly further lower without a meaningful bounce may be quite low now. Thus, a rebound here would not come as surprise to us, especially given the importance of this week from a fundamental point of view.
Brexit talks could trigger pound rally
Sterling’s downbeat start to the new week suggests market participants are not too optimistic about the prospects of a breakthrough in Brexit talks ahead of the next round of negotiations with Brussels on Tuesday. Recent talks have yielded no results and the pressure is growing on Prime Minister Theresa May to come up with a better proposal over the Irish border issue. But this extremely negative sentiment towards the pound makes us wonder whether the currency will stage a surprise reversal. After all, there is always a chance that an agreement could be reached, especially if the UK agrees to remain in the customs union after its full departure from the EU in 2021. A report by the Daily Telegraph suggests that the UK is prepared to remain in the customs union to avoid having a hard land border with Ireland. This outcome would certainly minimize the impact of Brexit on the boarders and economy, but could undermine the result of the referendum. However, it would most certainly be a positive outcome for the pound.
UK inflation is expected to have remained unchanged
The other key event risk is the publication of the latest inflation figures from the ONS on Wednesday. Headline Consumer Price Index (CPI) is expected to have remained unchanged in April at 2.5% year-over-year, while core CPI is seen easing down to 2.2% from 2.3%. The renewed weakness in the pound is likely to have pushed the costs of imports, with analysts expecting PPI input to have risen by 1.1% month-over-month. Meanwhile, the retail price index measure of inflation is seen rising to 3.4% from 3.3% previously.
GBP/USD tests key support at 1.3400
Any positive developments in Brexit negotiations and/or a positive surprise in inflation data could lead to a rebound in the British pound/U.S. dollar (GBP/USD) currency pair, which had extended its decline to 1.34 at the time of this writing. This level had provided strong support and resistance in the past and given the oversold conditions (see the RSI) I wouldn’t rule out the possibility of a short-squeeze rally here. But for that to happen, the bulls will need to reclaim the broken 1.3455 support and then push the price back above the most recent swing high at 1.3570, which would therefore also reclaim the 200-day average. Lots of “IF’s” here but the possibility of a rally is there nonetheless. On the other hand, if resistance at 1.3455 holds firm and we see a subsequent breakdown below 1.3400 support then it is anyone’s guess how much further the cable could drop. But to be clear, we are on the lookout for bullish signs to emerge here.