We have covered the US dollar and the FOMC’s upcoming rate decision extensively so far this week, so I thought why not share some thoughts on a non-dollar currency pair today.
While there are a few candidates that I could have looked at, the GBP/JPY is the one that has stood out to me – not only from a technical point of view but for sound fundamental reasons as well.
Above all, the fact that we have rate decisions to look forward to on Thursday from central banks of Japan and the UK means this pair could turn volatile should at least one of these banks deliver a surprise in terms of forward guidance. But there are also other reasons to watch this pair, with the Tory leadership contest fast becoming a one-horse race.
BoJo softens tone towards Brexit
Boris Johnson is leaping in front of the chasing pack with Dominic Raab confirming he will also be backing BoJo now that he's been eliminated from the race to become the next UK Prime Minister.
The results of the second ballot of Conservative MPs saw Johnson secure 126 votes, with Jeremy Hunt miles behind in the second spot with just 46 votes. BoJo has softened his tone towards a hard Brexit, though, which is why the pound has stopped falling. At last night’s BBC TV debate, he said it would be "eminently feasible" but avoided offering an absolute guarantee that the UK will leave the EU by 31 October.
BoE is good at talking the talk…
…but it won’t walk the walk – not now anyway. The Bank of England will be deciding on monetary policy on Thursday and no one is expecting any new announcements.
Some BoE policy makers have recently suggested that interest rates should be higher than where they are at the moment, because UK data has been surprisingly resilient. However, with other major banks turning dovish and some already cutting interest rates amid concerns over a global slowdown, and not to mention ongoing political and Brexit uncertainties here in the UK, the BoE may well provide a more dovish assessment of domestic interest rates than the markets expect.
So, we don’t expect the pound to find any meaningful support from this source.
Ahead of the BoE rate decision, we will also see the release of UK retail sales. With expectations pointing to a 0.5% drop in headline month-over-month sales, there is the scope for a positive surprise. But whether the pound will react to this is another matter, although the slightly stronger core CPI today did help fuel a mini rally.
BoJ running out of ammunition
As far as the Bank of Japan is concerned, well it has almost run out of ammunition, so like the BoE its hands will also be tied, and no change is expected at the conclusion of its meeting tomorrow. We also don’t expect any new policy announcements, although we can be and have been wrong before.
With other major global central banks having taken sharp U-turns on interest rates, there is the potential for the BoJ to introduce further stimulus in the coming months should the health of the global and the export-oriented Japanese economies deteriorate further.
Overnight news that exports contracted 7.8% year-over-year and that they were down for a 6th consecutive month with export volumes also declining for a seventh straight month, could alarm Japanese authorities. But will it be enough of a concern for the BoJ to consider further easing ahead of the G20 summit in Japan, especially in light of the US government becoming increasingly vocal in accusing many of her trading partners (such as China and the EU) as currency manipulators?
Japan is a special case given its prolonged fight against deflation, so it may be spared from being labelled a currency manipulator. Still, the fact that the yen has strengthened noticeably over the past few months (amid haven flows owing to the escalation of trade wars and other risks) must be frustrating to say the least for the BoJ and the Japanese government. But with QE at full throttle and interest rates in the negative, how much further can the BoJ loosen monetary policy?
GBP/JPY’s hammer candle could be a bull trap
Although the GBP/JPY created a hammer candle yesterday and there has been some further bullish follow-through so far in today’s session, potentially signalling the end of the current downtrend, I am not convinced we have seen a major low just yet. Indeed, the Guppy was climbing towards potential resistance around 136.50/65 at the time of writing, meaning that the sellers could potentially re-emerge here ahead of the above central bank meetings.
For the outlook to turn more favourable for the bulls, we will need a break above the most recent high at 138.40 now. Until and unless that happens, the path of least resistance continues to remain to the downside for the GBP/JPY, with the next bearish objective being the liquidity underneath this week’s low at 135.40.
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