Sterling under Strain from Buckling Economy

With the Pound trending near multi-year lows against the Yen, the latest indicators of UK economic activity are foreshadowing a prolonged period of headwinds for the nation as it contends with internal and external developments that are weighing on the outlook. Between reduced economic momentum, deflationary pressures both domestically and from abroad, and a weak trade environment, there are few areas for optimism in relation to the Pound. Considering the pessimistic view towards economic activity ahead, the Pound has reacted to the more dovish bias of the Central Bank and data, falling towards new multi-year lows against the Yen. Although recently announced fiscal stimulus measures along with expanded asset purchases were expected to weaken the Yen, no such conditions have materialized, adding to the risk of further losses in the GBPJPY pair over the medium-term.

Diminished Prospects

Although received with much fanfare, the UK’s decision to leave the European Union has already had severe consequences for the economy. For one, construction and manufacturing activity have slid lower, heightening the risks of a technical recession over the coming quarters, especially if business investment remains weak. With no certainty in the path forward and many questions pertaining to the particulars of the exit still up in the air, the economic climate is likely to reflect worsening sentiment from individuals and businesses. The limbo created by “Brexit” is a risk that will not dissipate over the near-term, adding to the potential for further losses in the Pound as investors seek an exit from the considerable uncertainty facing the outlook. Furthermore, it has heightened the probability of additional interest rate cuts from the Bank of England in upcoming meetings.

Aside from the obvious collapse in certain economic indicators including services sector fundamentals, the UK is facing potentially disastrous consequences from deflation. While Japan has been mired in deflation off and on for decades now, the impact on economic activity, specifically consumer spending is worrisome. Although UK inflation has experienced a recent pickup, the question remains as to whether the improvement in conditions will last, or is merely just transitory. One development that will spur inflation near-term is the significant losses in the Pound which will make imported goods significantly more expensive, adding to upside pressure in consumer prices. However, this boost will just be temporary, with stronger consumption necessary to see a truly sustainable pickup in inflation. Hurting the GBPJPY’s prospects are not just internal UK developments, but the abundant policy failures of Abenomics.

Japan’s foray into increasingly more aggressive and extreme monetary and fiscal policies has thus far shown limited effectiveness. Judging the reaction to the latest fiscal stimulus announcement, markets remain unimpressed by the steps taken by Japanese officials, adding to the recent strengthening in the Yen. While part of the Yen strength can be attributed to carry-trades that are gradually being wound down amid collapsing global trade, a significant component is the disappointment in the steps taken by policymakers to reverse the deflationary slide.Instead of tackling the root of existing problems, the more superficial actions undertaken to restore the economy to its former glory are showing increasingly limited impact, with the appreciating Yen underlining the falling confidence. Even though economic developments in the UK are having a more visible impact on the GBPJPY pair, the outlook for neither region inspires much confidence, adding to the ongoing bearish bias.

Technically Speaking

Looking at GBPJPY from a longer-term perspective, the pair is deeply mired in bear market territory, exacerbated in large part by accelerated momentum to the downside. Evidence of this momentum pickup comes in the form of the 50 and 200-day moving averages, each of which are trending lower at an increased downward slope, acting as resistance against any prolonged rebound. Now that key support at 133.50 has been crossed to the downside, the next major level on the downside is multi-year lows at 128.80 reached back in July. Near-term, more evidence of the downside bias comes in the form of the descending triangle breakout formation emerging on the 4-hour candlestick chart. Any candlestick close below support at 132.25 would indicate a downward breakout, with 128.80 as the next target. However, should the downtrend line be broken, it could signal a near-term correction higher in the GBPJPY pair.