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GBP/USD paves way towards 1.35 as CPI climbs to 2.9%

Could we see a more hawkish Bank of England on Thursday? Surely the Monetary Policy Committee cannot justify keeping interest rates at the current record low level of 0.25% for too long after CPI inflation accelerated to 2.9% y/y in August, driven by a record rise in clothing and footwear. It rose more sharply than expected from 2.6% recorded in July, while other measures of inflation were also stronger than anticipated. The pound surged across the board and the GBP/USD hit a new 2017 high.

Mark Carney and his MPC colleagues are fully aware of the risks to economy if they were to tighten monetary policy more aggressively when inflation is overcooked. Even if they think inflation will fall back in the coming months, and there are good reasons why this may well be the case, there is always that danger that prices may remain elevated or even rise further. After all, the impact of the past depreciation of sterling has not been entirely passed through to the consumer as up until now some of the higher import costs have been absorbed by producers. But factory gate prices have been on the rise since the Brexit vote and last month’s 0.4% increase suggests they may be unable to absorb any further rise in costs. One of the main reasons why the BoE has so far resisted calls to tighten its belt has been due to the fact nominal wages have been rising at a slower pace compared to inflation, causing real wages to fall. Tomorrow we will find out whether the gap between wages and inflation has grown bigger or shrunk. The Average Earnings Index in the three months to July is expected to have risen to 2.3% year-over-year compared to 2.1% in June.

As a result of the stronger UK CPI data, the GBP/USD has now hit a new 2017 high above the previous high of 1.3263 and this week’s earlier high of 1.3222. If the buyers hold their ground above this 1.3222-1.3263 area now then we may see further range expansion to the upside later on this week. The next bullish objective is at 1.3395, the 127.2% Fibonacci extension level of the last corrective downswing in August. The 161.8% extension of the same move comes in at 1.3565, which stands just above the now breached 2009 low of 1.3505 level. As well as price making higher highs and higher lows since that post-Brexit flash crash, the moving averages are in the correct order too, now. With the 21-day exponential moving average moving above the rising 50-day simple moving average, which itself resides above the rising 200-day average, the trend is indeed objectively bullish.

Given the current bullish trend, the bears have little reason to step in at these levels unless the buying momentum fades in such a way that prices forms a distinct reversal pattern or there is a break in market structure. With that in mind, any move back below support and today’s low around 1.3160 would be bearish in the short-term outlook. If that were to happen, we could see a pullback towards – if not below – 1.30 handle again. As things stand, this scenario looks unlikely. But we do have at least two other market-moving events from the UK coming up over the next couple of days: the latest jobs and wages data on Wednesday and then the Bank of England meeting on Thursday. 

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