GBP/USD Breaks Lower on Signs of Diverging Monetary Policy

GBP/USD has made an important technical break which signals potentially more losses to come. The trigger came yesterday after Fed Powell’s speech which caused the dollar to rally broadly against its major counterparts.

While there was some speculation that the Fed might consider negative rates, Fed Chair Powell was more focused on fiscal stimulus in his speech yesterday. He indicated that the economic recovery could be lengthy and highlighted the importance of support from elected officials via spending and taxation.

Powell dismissed the idea of negative rates by referencing back to a meeting in October where Fed members unanimously decided that there were better tools available than taking rates into negative territory.

The Fed Chair spoke about how the virus can cause liquidity issues for some businesses over the short-term which they can help with. However, if the economic downturn drags on for too long, these liquidity issues could turn into solvency issues that stand to have a long-lasting negative impact on the economy.

While Powell didn’t close the door on further easing, his focus on the importance of fiscal stimulus suggests that the Fed is not leaning towards increasing the size of its monetary policy easing efforts over the near-term.

This is in contrast to the Bank of England who met last week. Two out of seven members had voted to increase their bond-purchasing program by 100 billion pounds last week. Further, comments from BoE Governor Bailey following the meeting signaled that the central bank may look to ease further as soon as the June meeting.

The expectation of a divergence in monetary policy stands to put pressure on GBP/USD after a technical break that already highlights downside potential.

Technical Analysis

Rallies in GBP/USD were blocked twice in April by the 200-day moving average near 1.2650. This has resulted in a double top pattern and a bearish break below the late April low yesterday has activated the pattern.

The downside target for this pattern falls around 1.1890.

While the pair has activated the pattern, downside momentum is lacking. At the same time, the pair is on a cliff’s edge at this stage and it might only take a small push for a break lower.

Developments in the US Dollar index (DXY) will be important. The index does not share the same technical outlook as it remains within a broader range that has been playing out since late March.

DXY would need to rally another half percent to signal a bullish break out which is quite significant considering where GBP/USD is currently trading.

Recovery rallies in GBP/USD could be met with sellers at the breakout point of 1.2266. How the pair reacts from this level, were it to retest it, should provide some indication of how many traders are watching the double top pattern.

A break above yesterday’s high of 1.2336 would tend to invalidate the technical pattern and its negative implications.

Bottom Line

• GBP/USD has broken to fresh five-week lows as the dollar was boosted by Powell’s speech.
• A double top pattern is in play although bears will want to see an acceleration in downward momentum for confirmation.