GBP/JPY rally may accelerate on widening rate differential between UK, Japan

If the pound is going to stay strong in the short-term then its best bet would be against her weaker rivals – currencies where the central bank is still dovish. Thus, the GBP/JPY stands ready to benefit as the interest rate differential – or expectations thereof – between Japan and the UK widens.

The Bank of Japan left interest rates and monetary policy unchanged overnight as expected, but the yen weakened nonetheless as it lowered its inflation projections. The inflation forecast for 2017 was revised to 0.8% from 1.1% and for 2018 to 1.4% from 1.5% previously. With Prime Minister Abe’s mandate solidifying after the Japanese elections, and given these downwardly revised inflation projections, the BoJ is now likely to keep monetary policy extremely accommodative for the foreseeable future as Japan tries to reduce the threat of deflation. This should continue to put downward pressure on the yen.

While the Japanese yen was among today’s weakest of currencies, the British pound was among the strongest. Sterling was higher against all its major rivals at the time of this writing. Market participants are probably positioning themselves for a likely interest rate increase from the Bank of England on “Super Thursday”. If the BoE does raise rates then the pound may appreciate further in the short-term outlook, even if this outcome is widely expected. The BoE’s policymakers may also revise their inflation projections upwards, which may give the pound an additional boost.

If the pound is going to stay strong in the short-term then its best bet would be against her weaker rivals – currencies where the central bank is still dovish. Thus, the GBP/JPY stands ready to benefit as the interest rate differential – or expectations thereof – between Japan and the UK widens.

This pair is also currently benefitting from technical buying pressure as the trend is objectively bullish. Not only is price making higher highs and higher lows, but the moving averages are all pointing in the right direction, too: the 21-day exponential moving average is rising above the 50-day simple MA, which, in turn, is residing above the now-rising 200-day MA. The behaviour of price action therefore clearly suggests it wants to push higher. There are a couple of potential resistance levels to keep an eye on, at around 151.50 and then 152.85/95 area. I think these levels will give way soon, paving the way for a run towards the Fibonacci extension levels shown on the chart, below. Among these targets, the 156.00-156.50 area is the most interesting to watch as several Fibonacci extension levels converge there, making it an ideal location for profit-taking.

While everything currently point higher, nothing should be taken for granted in the FX markets. Consequently one needs to be at least prepared for the possibility of price taking an unexpected turn. The bulls clearly would want the now broken resistance level at 150.00 to turn into support on a potential re-test. If this fails to hold price up, we would put on hold our bullish view on any move below the next key level at 149.00, as this has been a key inflection point recently. Our bullish view would be completely invalidated on a potential break below the most recent swing low at 147.00.  

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