GBP/USD - Weakness to be short lived?

GBP/USD clocked a high of 1.3126 on Tuesday before the drop in the UK inflation pushed the pair down to 1.3005 levels. The spot trimmed losses to end the day at 1.3039, largely on the back of broad based USD weakness.

BoE to keep rate hike talk alive

The UK’s inflation rate unexpectedly dropped to 2.6% in June, down from 2.9% in May. The drop is largely attributed to lower energy prices. It is widely believed that the drop in inflation eases pressure on the Bank of England (BoE) to hike rates. 

However, real wages are likely to remain in the negative territory as the wage growth still lags the growth rate of inflation. Thus, the BoE is likely to keep the talk of an interest rate hike alive via hawkish sound bites in order to avoid a sharp drop in GBP and a rise in imported inflation. Thus, the inflation-led drop in the GBP/USD could be short lived. 

1-month 25 delta risk reversal ticks higher

The 25 delta risk reversal rose to -0.50 on Tuesday from Monday’s print of -0.60. This indicates a drop in demand for downside protection at a time when the GBP/USD pair is looking heavy. Thus, the weakness in the GBP/USD pair could be short lived, especially if the 25 delta risk reversal extends gains today and is accompanied by a rise in the 1-month at-the-money option volatility (currently at 7.325). 

On the contrary, a drop in the risk reversal and an uptick in the volatility would signal the pullback in the GBP/USD could be extended further to 50-DMA support of 1.2881. 

GBP/USD outlook by Kathy Lien from BK Asset Management

“With consumer prices stagnating in the month of June, it is hard for anyone to believe that the BoE will raise interest rates this year, let alone in August.  The year over year inflation rate slowed to 2.6%, the first pullback since October.  If retail sales also miss GBP/USD could drop the 1.28 handle.”

GBP/USD Technical Levels

FXStreet Chief Analyst at Valeria Bednarik says, “The pair managed to bounce amid persistent dollar's weakness, with the 4 hours chart now showing that the price is battling to recover above an anyway bullish 20 SMA, whilst the RSI indicator aims modestly higher within neutral levels, and the Momentum heads lower around its 100 line, all of which limits chances of a bearish move, but is not enough to confirm a firmer recovery.

• Support levels: 1.3000 1.2965 1.2920
• Resistance levels: 1.3070 1.3125 1.3160