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GBP/USD analysis: Pound sinks to March 1985 levels. Is the worst yet to come?

13:43, 16 September 2022

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Financial market chart. Currency pair GBP/USD
Forex candlestick pattern. Trading chart concept. Financial market chart. Currency pair GBP/USD – Photo: Shutterstock

The last time the pound (GBP/USD) traded below 1.14 against the dollar was in March 1985, when seven-time Formula 1 world champion Lewis Hamilton was born just two months earlier in Stevenage, UK.

On the 30th anniversary of the 1992 Black Wednesday, the pound fell to its lowest level in more than 37 years, losing 17% of its value since the start of the year, amid dismal economic data painting the UK economy on the brink of recession. 

Retail sales in the UK plunged in August, falling 5.4% year-over-year and 1.6% month-over-month well below expectations of a 4.2% and 0.7% drop, respectively. 

The UK CPI report released this week on Wednesday left little room for optimism, despite the fact that overall inflation in the UK fell to 9.9% in August from 10.1% in July. The core inflation rate, which excludes energy and food, reached a new record high of 6.30% year-over-year in August 2022, indicating that the inflationary crisis has already spread like a wildfire to the entire UK consumer basket.

GBP/USD monthly chart: 1.07 next stop?

a technical chart showing GBP/USD in a monthly timeframeGBP/USD monthly chart – Photo: Capital.com, Source: Tradingview

Monthly timeframes in the GBP/USD price chart are needed to get back to 1985 levels.

According to the monthly GBP/USD chart, the next significant support is now located at 1.077 (February 1985 lows), which marks the all-time low for the pound.

The monthly relative strength (RSI) index is deep in "oversold" territory, but this hasn't been enough to prompt buying on dips so far. GBP/USD's monthly RSI dropped even lower during the 1984 and 2008-2009 crises.

The long-term major bearish trend, starting from the highs of $2.07 in November 2007, continue to follow a falling wedge pattern. The support trendline connecting lower lows – 1.43 in February 2009 and 1.22 in September 2016 – is pointing straight towards the all-time lows at 1.077.

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GBP/USD daily chart: Bears in command

The daily chart of the GBP/USD pair also shows a steep declining channel, with the pair hitting -17% year-to-date.

The daily RSI has hovered below the mark 50 since mid-August, reaching oversold levels on August 31 and then exiting shortly thereafter. 

GBP/USD

1.12 Price
+0.320% 1D Chg, %
Long position overnight fee -0.0038%
Short position overnight fee 0.0001%
Overnight fee time 21:00 (UTC)
Spread 0.00060

USD/JPY

144.77 Price
+0.260% 1D Chg, %
Long position overnight fee 0.0036%
Short position overnight fee -0.0106%
Overnight fee time 21:00 (UTC)
Spread 0.040

EUR/USD

0.98 Price
-0.150% 1D Chg, %
Long position overnight fee -0.0086%
Short position overnight fee 0.0025%
Overnight fee time 21:00 (UTC)
Spread 0.00024

AUD/USD

0.64 Price
-1.540% 1D Chg, %
Long position overnight fee -0.0033%
Short position overnight fee -0.0011%
Overnight fee time 21:00 (UTC)
Spread 0.00040

The most recent GBP/USD price action, however, sends the oscillator pointing south once more, indicating that bears maintain complete control of the short-term trend.

"God save the Pound": Can the BoE come to the rescue?

A chart showing GBP/USD vs rate spreadGBP/USD decoupled from short-term UK-US rate spread – Photo: Capital.com, Source: Tradingview

The pound's massive depreciation is justified by the rapid deterioration of the UK macroeconomic fundamentals, as explained here.

The Bank of England (BoE) is in the worst possible position for a central bank because it must raise interest rates even though the economy is heading to a recession.

However, the anticipated rate hike by the Bank of England may not be sufficient to significantly reverse the pound's downward trend.

Even if the BoE hikes interest rates by 75 basis points on Thursday 22, as I expect, this move won't reduce rate differentials with the Federal Reserve, which will likely deliver a similar hike a day earlier. 

Additionally, GBP/USD has already started to decouple from its correlation with short-term interest rates between the UK and the US. As the chart above shows, the 2-year yield spread between gilts and Treasuries has recently moved in the opposite direction of the GBP/USD trend.

This means that in the currency market, investors are beginning to factor in downside risks other than rate differentials for the pound, such as the likelihood of inflation spiralling out of control and necessitating emergency interest rate hikes from the BoE.

As UK real interest rates remain close to record lows of -8%, the market is likely to test the BoE's ability to deliver outsized interest rate hikes in the coming period. 

UK policy rates minus inflation rate at all time lowsReal interest rates in the United Kingdom are at their lowest levels ever – Photo: Capital.com, Source: Tradingview

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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
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