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Pound becomes Forex favorite amid positive external background and expectations of repo rate increase

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Relevance up to 11:00 2022-01-08 UTC+00

No matter how vile the Bank of England may behave, it seems to achieve its goals. The refusal to raise the repo rate in November, when everyone expected such a step from Andrew Bailey and his colleagues, followed by a tightening of monetary policy in December, is yielding results. The 10-year inflation expectations have crept down, falling at the fastest pace since October 2019. UBS believes that in 2022 they will return to the range of 3-3.5%, contributing to the strengthening of the pound.

Despite the fact that the BoE predicts an acceleration of consumer prices in Britain to 6% over the next few months, the indicator should soon slow down. If this is not achieved, an inflationary spiral can be created, when expectations of high CPI levels become a self-fulfilling forecast. The best way to slow down inflationary expectations is to raise the repo rate, followed by a hint of a continuation of the monetary restriction cycle. This is what BoE did in December.

As a result, the real yield of British bonds began to grow, which lends a helping hand to the bulls on GBPUSD. For the first time since the beginning of November, 10-year interest rates have risen above -3%.

Dynamics of real yields on British bonds

Expectations of the continuation of the cycle of repo rate hikes by the Bank of England and positive external background allowed the sterling to climb to the area of 2-month highs against the U.S. dollar. The pound is called the Great British Peso (GBP) for a reason: it is sensitive to changes in global risk appetite, as in such conditions it is easier for London to raise capital to finance the negative current account balance. In this regard, the fact that inflation in the United States is tending to 7%, and the average return on the global debt market, according to Bloomberg research, is 1.33%, supports not only risky assets but also the bulls on GBPUSD.

Sterling is drawing strength from expectations of a further rise in the repo rate from 0.25% to 0.5% in February. Moreover, raising borrowing costs to 0.5% enables the BoE to stop reinvesting QE earnings. That is, it can be perceived by investors as the most aggressive Central Bank, tightening monetary policy. Indeed, if the balances of the Fed, the ECB, and the Bank of Japan continue to grow, and the BoE balance shrinks, this will make the pound almost the top favorite among the G10 currencies in 2022.

Dynamics of the balance sheets of the world’s leading central banks

Monetary restriction by the Bank of England and positive external background associated with expectations of getting rid of the pandemic and recovery of the global economy make the outlook for GBPUSD bullish. Moreover, a significant part of the positive has already been incorporated in the quotes of dollar pairs, which increases the risks of profit-taking by sellers and the continuation of the sterling rally against the U.S. dollar.

Technically, finding GBPUSD above the moving averages and fair value signals serious bullish momentum. In such conditions, the update of the December high at 1.355 or a rollback followed by a rebound from the supports at 1.3465 and 1.3415 should be used for purchases.

GBPUSD, Daily chart

*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.

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