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Summary: Short-term inflation expectations in the UK are expected to decrease soon, with a corresponding softening of the pound as expectations for Bank of England interest rate hikes diminish.

Fundamentals

Recent UK CPI data indicates that food inflation has peaked, and supermarkets have announced price reduction plans. Starting from July, utility bills are also expected to decrease. This should result in more significant inflation declines in the coming months, leading to market skepticism regarding the extent to which the Bank of England will need to raise interest rates in the future.

Simultaneously, the fact that the BoE has been hesitant for such a long time implies that eventually, it will be necessary to adopt a more restrictive monetary policy to stabilize inflation expectations and limit second-round effects. This could create significant pressure on the economy. On one hand, a more hawkish stance from the BoE (which has been the recent impression) would benefit the pound, but concerns about the impact on the economy leave a bitter taste. This could make it more challenging for the pound to rally, regardless of ongoing increases in rate expectations.

In the market, net long positions in the pound are currently at their highest level since July 2014. For a currency like the pound, which is still affected by weak economic fundamentals, the long positioning appears somewhat excessive.

In the second half of June, the pound fell against both the U.S. dollar and the euro, indicating investors' reluctance to continue buying the pound.

Although it is widely expected that the Bank of England may continue to raise interest rates in the coming month, we believe that the upside potential for the pound will be limited due to concerns over the tightening of monetary policy increasing the risk of an economic downturn. As demonstrated multiple times last year, rate hikes by the Bank of England do not always boost the pound.

We anticipate that the Bank of England will raise rates two more times, whereas the current market expectation is for five rate hikes. This will erode some of the support for pound yields. Our outlook for the pound is neutral, but we believe there is an increased risk of a short-term correction unless there are significant downside surprises in U.S. data, even though GBPUSD has not shown any signs of a bearish reversal yet.

Technical Analysis

Since October 2022, GBPUSD has been in a long-term uptrend and is supported by the long-term uptrend line. In the short term, the pair experienced a correction from the 14-month high of 1.2847, but quickly took hold and reversed higher. Given the higher highs and higher lows, the technical outlook remains bullish.

However, as previously mentioned, the foundation for further short-term upside is not yet solid. Currently, bears are looking to break below the key level of 1.2700, pushing prices below the support at 1.2600. If this bottom gives way, bears may face the rising trendline connecting the lows since October 2022 and the 50-day SMA before testing the resistance at 1.2445. A break below that region could set the stage for a retest of the May low at 1.2307. Therefore, the closing price in the coming days will determine the direction's choice.

If the recent rebound continues, the focus may shift towards the recent 14-month high at 1.2849. Further testing of previous highs by the bulls may encounter resistance at the key psychological level of 1.3000. A breakthrough above that level could lead the bulls to target the March 2022 low at 1.3160, which may serve as future resistance.

Overall, the GBP's short-term strength is not sustainable, despite the overall uptrend. Further upside requires ongoing adjustments to the upward structure. In terms of strategy, it's recommended to go short at highs.

Trading Recommendations

Trading Direction: Short

Entry Price: 1.2740

Target Price: 1.2600

Stop Loss: 1.2850

Valid Until: 2023-07-20 23:55:00

Support: 1.2689, 1.2658, 1.2627

Resistance: 1.2782, 1.2841, 1.2850