Introduction to the Bank of England (BoE) and its rate hikes
The Bank of England (BoE) plays a crucial role in shaping the economic landscape of the United Kingdom. As the country's central bank, it is responsible for maintaining monetary stability and promoting the overall well-being of the economy. One of the critical tools at the disposal of the BoE is the power to adjust interest rates.
During the past 14 meetings, the BoE has raised rates and has garnered significant attention from traders and other market participants. These rate hikes refer to the increase in the benchmark interest rate set by the BoE, known as the Bank Rate. The Bank Rate influences borrowing costs for individuals, businesses, and financial institutions, subsequently impacting consumer spending, investment decisions, and overall economic activity.
Understanding the rationale behind the BoE's rate hikes is crucial for investors, as it provides insights into the central bank's economic outlook. Typically, rate hikes are implemented when a central bank believes the economy is growing steadily, with inflationary pressures building up. Central banks aim to cool down the economy by increasing interest rates and preventing excessive inflation.
However, the timing and magnitude of rate hikes are not solely determined by economic growth and inflation factors. The BoE also considers other economic indicators, such as employment data, wage growth, productivity levels, and global economic trends. These indicators help shape the BoE's decision-making process and provide further context for investors to understand the rationale behind rate hikes.
Traders may want to closely monitor the BoE's rate hike decisions and the accompanying economic indicators to assist in making informed trading decisions. Rate hikes have the potential to impact various asset classes, including bonds, equities, and currencies. By staying informed and understanding the implications of these rate hikes, traders can position themselves strategically and navigate the market volatility that often accompanies such policy changes. Following fundamental data can reveal supporting data for a trading position.
Central bank interest rate changing cycles are usually long-lasting. The market can experience a significant pause between these cycles as they determine the economic impact of the recent interest rate modifications.
Understanding the role of interest rates in the economy
At its core, the interest rate is the cost of borrowing money. When central banks, such as the Bank of England (BoE), adjust interest rates, it has a ripple effect throughout the economy. These adjustments are primarily aimed at managing inflation, promoting economic growth, and maintaining financial stability.
When interest rates are lowered, borrowing becomes cheaper, stimulating consumer spending and business investment. This, in turn, fuels economic growth as individuals and businesses have more disposable income and access to capital. Lower interest rates encourage borrowing for big-ticket items like homes and cars, boosting the housing and automotive industries.
Conversely, when interest rates are raised, the cost of borrowing increases, decreasing consumer spending and business investment as borrowing becomes less affordable. Higher interest rates can dampen the housing market, making mortgages more expensive and potentially slowing construction and real estate activity.
Recently, the BoE governor spoke to the UK Parliament and stated that the central bank was approaching the conclusion of its interest rate hikes. The timing of this currency weakening statement coincides with a dominant selling seasonal pattern.
How can traders take advantage of what seems like the perfect storm of the BoE, stating it is ready to pause rate hikes during its fiscal second quarter, which is traditionally a weak period for the British Pound (GBP)?
Analyzing the strategy for the upcoming seasonal sell pattern for the GBP
In a recent article for Barchart, "Cracking the Currency Code: Analyzing Seasonal Patterns and the Future of the British Pound," I discussed a prior seasonal sell pattern found by Moore Research Center, Inc. (MRCI) and the supporting analysis I used for the trade.
Source: MRCI
MRCIs research revealed a seasonal sell pattern (yellow box) from early August to early September.
I commented, "MRCI research has uncovered a pattern where the GBP has closed lower on approximately September 02 than on August 03 in 12 of the recent 15 years for an 80% win rate. During this period, the seasonal pattern had three years without a daily closing drawdown."
Fundamentally, MRCI had observed, "The pound has usually traded lower into September on its way to a significant low in October at the end of the second British fiscal quarter."
What's next?
As the GBP fiscal second quarter does not end until October, another MRCI seasonal pattern is arriving soon to offer a potential opportunity for another GBP short position.
Source: MRCI
MRCI research states the GBP closed lower on approximately October 06 than on September 18, 93% of the time during the past 15 years (14-1.) The average duration of this trade is 19 calendar days.
The Relative Strength Index (RSI) study is near an oversold level and may need a relief rally before selling the GBP. There is plenty of time before the seasonal window opens for this rally to occur.
Supporting our bearish GBP bias, the US Dollar (USD) has a solid seasonal buy pattern, while the GBP has a seasonal sell pattern.
Source: MRCI
The seasonal daily chart of the USD shows the 15-year pattern for prices to rise (between the red lines), which is inversely correlated with the GBP.
Source: MRCI
During the past 60 days, the USD (DXU23) and the GBP (BPU23) have closed inversely 93% of the time.
Source: MRCI
During the past 180 days, the USD and GBP had closed inversely 53% of the time. The shorter 60-day table reveals the inversion has increased considerably, supporting the current GBP downtrend and upcoming seasonal GBP sell.
In closing
Traders could use the GBP/USD pair to participate using the spot forex market. They may also use the standard-size futures contract 6B (Barchart B6) or the micro-sized M6B (Barchart MBU.)
In this article, we dove deep into the analysis of a seasonal sell pattern and its impact on the future of the British Pound. Supporting the trade, the inverse USD seasonal buy during the GBP seasonal sell increased the probability of this trade. It's important to note that while seasonal sell patterns can provide valuable insights, they should not be the sole basis for trading decisions. Traders must also consider other technical and fundamental indicators, risk management strategies, and market conditions to make well-informed and balanced trading choices.
The BoE governor has stated they are ready to pause interest rate hikes, which would be bearish for GBP prices.
On the date of publication, Don Dawson did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
