Pound Sterling finds support while higher UK gilt yields keep downside intact

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• The Pound Sterling recovers slightly after facing a sharp sell-off in the last few trading days, with investors focusing on the UK CPI data for December on Wednesday.

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• The weak outlook of the British currency stays afloat amid higher UK gilt yields.

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• Investors await the US inflation data, which will influence expectations for the Fed’s policy outlook.

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The Pound Sterling (GBP) finds temporary support on Tuesday after facing a sharp sell-off in the last few trading days due to rising yields on the United Kingdom (UK) gilts. The 30-year UK gilt yields have risen to near 5.47%, the highest since 1998, due to multiple tailwinds, such as higher uncertainty about incoming trade policies under the administration of United States (US) President-elect Donald Trump, persistent inflationary pressures and slower growth expectations in Britain.

A healthy rise in UK gilt yields has resulted in a discomforting situation for UK Chancellor of the Exchequer Rachel Reeves, who was already facing backlash from employers for raising their contribution to National Insurance (NI) and leaving little fiscal headroom if the situation turns upside down. 

Market participants expect the UK government to turn to foreign financing to fund routine spending to avoid rising domestic borrowing costs. However, the British finance ministry maintains its non-negotiable promise to rely on borrowing only for investment, not for addressing day-to-day spending.

Meanwhile, investors shift their focus to the UK Consumer Price Index (CPI) data for December, which will be released on Wednesday. Investors will pay close attention to the UK inflation data as it will drive market expectations for the Bank of England’s (BoE) likely interest rate action in the February policy meeting.

Analysts at UBS expect the BoE to cut interest rates next month, with more reductions remaining in the pipeline later this year. UBS said that higher borrowing costs, which are flowing into the real economy, are “tightening financial conditions”. The Swiss bank added, “Inflationary pressures are present but fading, so a cut in February, with more later this year, remains the base case.”

Daily digest market movers: Pound Sterling bounces back against US Dollar

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• The Pound Sterling moves higher to near 1.2250 against the US Dollar (USD) in Tuesday’s European session after rebounding from a fresh yearly low of 1.2100 on Monday. However, the outlook of the GBP/USD pair remains weak amid firm expectations that the Federal Reserve (Fed) will deliver less interest rate cuts this year. The US Dollar Index (DXY), which tracks the Greenback’s value against six major currencies, ticks lower to near 109.60 at the time of writing. The USD Index corrects slightly after posting a fresh more-than-two-year high above 110.00 on Monday.

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• Strategists at Barclays have revised down their expectations for the number of interest rate cuts by the Fed this year. The bank expects the Fed to deliver only one cut this year, compared to two previously, based on stronger-than-expected US labor market data and persistent inflation expectations.

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• Meanwhile, investors await the US CPI data for December, which will be released on Wednesday. Year-on-year headline inflation is expected to have accelerated to 2.8% from 2.7% in November, with core reading growing steadily by 3.3%. 

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• Signs of stubborn price pressures could accelerate expectations that the Fed will avoid cutting interest rates this year. However, a slowdown in inflationary pressures is unlikely to boost the Fed’s dovish bets, as investors expect incoming policies under Trump’s administration, such as immigration controls, tax cuts, and tariff hikes, to fuel the growth rate.

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Technical Analysis: Pound Sterling rebounds slightly as RSI turns oversold

The Pound Sterling rebounds slightly to near 1.2250 against the US Dollar in Tuesday’s European session after refreshing its more-than-a-year low to near 1.2100 on Monday. However, the outlook for Cable remains weak as the vertically declining 20-day Exponential Moving Average (EMA) near 1.2430 suggests that the near-term trend is extremely bearish.

The 14-day Relative Strength Index (RSI) rebounds slightly after diving below 30.00 as the momentum oscillator turned oversold. However, the broader scenario remains bearish until it recovers inside the 20.00-40.00 range.

Looking down, the pair is expected to find support near the October 2023 low of 1.2050. On the upside, the 20-day EMA will act as key resistance.