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    GBP/USD bears eye 1.45 as UK flirts with deflation

    The headline rate of inflation in the UK last month remained at its lowest level since records began in 1989. The Office for National Statistics reported that the consumer price index (CPI) was at zero year-over-year in March, unchanged from February. Although this was widely expected, other measures of inflation were mostly weaker than anticipated, causing the pound to slide as speculators pushed their Bank of England rate hike expectations further out.  The core CPI, for one, was just 1 per cent, its lowest level since July 2006. On top of this, the retail price index (RPI) edged lower to 0.9% from 1.0% previously while the house price index (HPI) dropped to 7.2% from 8.4% previously. One bright spot was in producer prices as input costs unexpectedly increased by 0.3% month-over-month in March and output prices (i.e. the price of goods sold by manufacturers)  increased by 0.2 per cent.

    But with the recent sharp falls in prices and uncertainty over the UK election growing, consumers may delay planned purchases of expensive items such as cars in the hope that they will get a better deal in the future. This could potentially send the UK economy into a deflationary spiral. And worryingly still, with interest rates already being at historically low levels, there is not much room left for manoeuvre in terms of monetary policy. That said however, most economists, including those at the Bank of England, are still optimistic that inflation will soon return. Indeed, growth in the euro zone economy – the UK’s largest trading partner – is gathering pace thanks mainly to both a weaker euro and oil price. Today this was evidenced by a 1.1% surge in the euro zone industrial production for the month of February. A growth of 0.3% was expected. There were even signs that inflation was returning in the single currency bloc as Italy’s monthly prices rose 2.1% while in Spain consumer prices were up 2% in March.

    Following the publication of the UK inflation figures the GBP/USD dropped to just over 1.4600 before bouncing back 40 pips as traders took profit ahead of the US data in the afternoon. At 13:30 BST, the US Census Bureau will release the latest retail sales numbers. The headline figure for the month of March is expected to show a growth of 1.1% in sales while core sales are seen rising 0.7% on the month. If correct, or better still, higher, the US dollar may extend its gains for a seventh day against a basket of foreign currencies. The Dollar Index is currently consolidating just below the psychologically-important 100 handle. This could potentially deliver the final nail in the coffin for the Cable and cause it to drop to a fresh multi-year low.

    From a technical point of view, the GBP/USD is currently holding somewhat uncomfortably above a key Fibonacci support area around 1.4575/90. As can be seen on the 4-hour chart (in figure 1), this is where the 161.8% extension levels of two price swings converge. If this level were to break down then there is nothing major seen until the psychologically-important 1.45 handle. Meanwhile the short-term resistances to watch are at 1.4680 and 1.4740, levels that were formerly support and/or resistance. But even if the GBP/USD breaks above 1.4740, the long-term bias would remain bearish for as long as it holds below the key 1.4950/1.5000 resistance zone. Meanwhile the 4-hour RSI is showing some bullish divergence which indicates that bearish momentum may be waning a tad.

    However, the more significant monthly chart (in figure 2) shows an even more bearish picture. On this time frame, another popular momentum indicator, the MACD, has created a bearish crossover and also broken below the key zero level. Significantly, there is not much support visible now until around 1.4290/4300, an area which marks the convergence of the 78.8% Fibonacci retracement level of the 2009-14 upswing with the long-term trend line (derived from connecting the low points of 1985 with 2009 and extending it to the future).

    Therefore, if the GBP/USD goes on to break below the abovementioned support at 1.4575/90 and also take out the psychological level of 1.4500 then 1.4300 could be the next major stop. Admittedly this level is still some 300 pips or so away, so the bears would have to chop some woods to get there. But the markets can move quickly and we may get there by the end of the week, US data permitting.  But with the dollar index struggling around the 100 level, a rally in the GBP/USD and other major currency pairs is also equally possible. As always, traders and analysts should approach the markets with an open mind.  

    Figure 1:



    Figure 2:


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