27.05.202010:07 Forex Analysis & Reviews: GBP/USD. Bailey's bluff and dollar's temporary strengthening

The pound paired with the dollar conquered the 23rd figure yesterday, updating along the way a two-week high. Most experts associated this trend with the weakening of the US currency and with the progress in the negotiations between London and Brussels. However, there is another fundamental factor that contributed to the strengthening of the British pound.

First, you need to recall why the pound fell for almost two weeks. It all started with the release of disappointing statistics that reflected the decline of the British economy amid the coronavirus crisis. April data a priori could not be in the "positive zone" – traders were only interested how deep the decline of key indicators was. It turned out that the real picture is much worse than expected. Almost all the parameters went into the negative zone, demonstrating the strongest decline in the economy. It was then that the first rumors appeared that the Bank of England might introduce a negative rate.

At first, these conversations seemed empty. After all, Andrew Bailey himself, having just been appointed to the post of head of the Central Bank, rejected this idea. But that was back in March, when Britain only "got acquainted" with the coronavirus. And when Covid-19 actually closed the country (and with it almost the whole world) for a month and a half, Bailey's position changed dramatically. Speaking to members of the Lower House of the British Parliament, he said that the Central Bank "is actively considering the option of reducing the rate to zero." Such a statement sounded like out of the blue, so it is not surprising that the GBP/USD pair collapsed to two-month lows, that is, to the middle of the 20th figure.

In addition, it became known during this period of time that the negotiations between London and Brussels failed once again. The head of the British delegation acknowledged that there was no agreement between the parties on almost all issues - from fishing and agriculture to pharmaceutical rules and tariffs. At the same time, he recalled that Boris Johnson does not intend to extend the transition period, and the negotiation deadline expires at the end of June. According to the head of the British government, it will become clear by this moment whether further negotiations have any prospects or whether the country should prepare for a new format of relations, without a trade deal. Many experts admit that Johnson once again "plays on the nerves" (as he did during the Brexit negotiations), but nevertheless, June remains the key month when the parties should come to at least some conclusions.

In other words, the risk of introducing a negative rate, as well as the uncertainty regarding the negotiations between London and Brussels, exerted strong pressure on the pound. Therefore, as soon as these topics "played with new colors", the British currency will likely increase.

Firstly, traders got a signal that the Bank of England does not really intend to reduce the rate below zero. Mostly, even before Haldane's comments, it was clear that Bailey's statement was more political (given where and under what circumstances he voiced it) - the head of the Central Bank did not have the power to single-handedly lower or raise the rate, and the rest of the Committee did not declare such intentions. The market hesitated for two weeks on this issue, but Bank of England chief economist Andrew Haldane put an end to this discussion yesterday. According to him, the English regulator "didn't even come close to the decision to switch to negative interest rates." He also recalled the negative effects of negative rates on UK banks and lenders who will experience margin pressure. In addition, Haldane noted that such a move by the Central Bank "will affect confidence in the economy as a whole."

All this suggests that the regulator considers the option of reducing the rate to the negative region to extraordinary measures - for example, if the UK is forced to quarantine again in connection with the second wave of the epidemic. However, if the British economy shows signs of recovery amid quarantine, then the Bank of England will probably not decide on such decisions.

The second factor supporting the pound was the Brexit issue. Although in this case we are already talking about the prospects for a transition period, in fact the dilemma is not much different from last year: either Britain enters into a trade deal with the European Union, or the single market closes before the British. As mentioned above, the parties parted in the middle of May without any result. Now, the positions of the negotiators have somewhat softened: the British said that a trade agreement with the EU could be concluded if the European Union compromises. A similar "wish" was voiced by Europeans. This week, there was information (albeit informal) that Brussels was ready to make concessions, but was waiting for similar actions from London. The negotiations themselves will begin on June 1, and this disposition of the parties inspired the gbp/usd bulls to conquer new price heights.

At the moment, the pair's growth has stopped. The reason is the general strengthening of the dollar against the backdrop of another surge in anti-risk sentiment. Donald Trump made traders nervous again, saying that Washington was preparing "something powerful" against China in response to the possible adoption of the scandalous national security law in Hong Kong. However, he noted that the measures being prepared are not related to sanctions. Trump promised to tell the details in a few days, so the continuing intrigue allowed the dollar bulls to remind themselves - the dollar index returned to the 99th figure again.

Nevertheless, the GBP/USD pair retains the potential for its further growth - especially if the rumors around the upcoming negotiations are positive. In this case, buyers will test the nearest resistance level again - 1.2355 (Kijun-sen line on the daily chart) and designate the next, more ambitious goal of the upward movement - 1.2530 (the upper Bollinger Bands line on the same timeframe).