Forex market update: GBP/USD, USD/JPY Forecast

Forex market update, the GBP/USD currency pair has shown notable volatility recently, establishing a trading range that traders should closely observe.

In a surprising turn of events, the UK Consumer Price Index (CPI) fell to 2.5% year-over-year in December, down from 2.6% and below forecasts of 2.7%. This unexpected decline indicates a slight easing in inflationary pressures, which has contributed to a more favorable outlook for the British pound. Concurrently, service sector inflation also decreased significantly, dropping to 4.4% from 5%, and well below the anticipated 4.8%. This cooling is particularly important as the Bank of England (BoE) monitors service sector inflation closely, which has previously hindered the central bank's ability to cut interest rates further.

Market Reaction to Inflation Data

Following the release of these inflation figures, market expectations for BoE rate cuts surged, adding 12 basis points to the projections for cuts in 2025. Current expectations now stand at 49 basis points for the year, although this remains short of the central bank's own forecast for four rate cuts in 2024. Typically, rising expectations for rate cuts would lead to a decline in the pound. However, today’s data also resulted in a significant drop in gilt yields, with the 2-year bond yields falling around 9 basis points, which tends to support the pound.

Challenges Ahead for the UK Economy

Despite the positive inflation data, the UK economy is not out of the woods yet. A recent survey by the British Retail Consortium indicated that two-thirds of retailers plan to raise prices in response to increased employer social security costs, presenting a potential hurdle for the disinflation outlook. Furthermore, the same survey revealed that around half of the finance directors at major retailers are considering reducing staff hours and headcounts, raising concerns about employment and economic activity.

There are growing worries regarding the trajectory of UK growth, which has been declining since the Labour Party came to power in July. This, along with persistent inflation, points to a stagflationary scenario that could pose significant challenges for policymakers moving forward. With UK GDP data set to be released soon, it will provide additional insight into the health of the economy.

US Inflation Data on the Horizon

Attention is also shifting to the upcoming US CPI report, expected to show an increase to 2.9% from 2.7%. If inflation rises as anticipated, it could dampen expectations for rate cuts, potentially strengthening the US dollar and exerting downward pressure on GBP/USD.

GBP/USD Technical Analysis
GBP/USD has experienced notable volatility, trending lower from 1.34 to a low of 1.21 at the start of the week. However, the price has since recovered and is trading back above the 1.22 level, with the Relative Strength Index (RSI) moving out of oversold territory. Although a long-term downtrend remains intact, the presence of a hammer candlestick pattern and long lower wicks on recent candles suggest that a bullish reversal might be on the horizon.

Key Levels to Monitor

Support Level: 1.21
Resistance Level: 1.24 to 1.25
Buyers are likely to target gains above the April low of 1.23, with 1.25, the December low, coming into focus. Conversely, sellers will need to break below the 1.21 low to push prices down to 1.2050, the 2023 low, and potentially to the psychological level of 1.20.

USD/JPY Falls Ahead of US CPI

Yen Strength Amid Hawkish BoJ Comments
In contrast, USD/JPY is experiencing downward pressure as the yen strengthens, following hawkish comments from Bank of Japan (BoJ) Governor Ueda. His remarks emphasized the central bank's readiness to raise borrowing costs if the economy continues to improve, adding further complexity to the currency pair's outlook. Additionally, Finance Minister Kato's comments about potential government intervention in the foreign exchange markets have also supported the yen.

US Inflation Data's Potential Impact
All eyes are now on the upcoming US inflation data, expected to show a CPI increase to 2.9% from 2.7%. This would mark the fifth consecutive monthly rise, moving further away from the Federal Reserve's 2% target. Concerns about persistent inflation have already led to elevated Treasury yields, driven by a resilient US economy and expectations of inflationary policies in the wake of Trump's administration.

If inflation comes in hotter than expected, it could lead to a further resistance against Fed rate cut bets, with the market currently pricing in only one rate hike by the end of this year. Such a scenario could see USD/JPY recover and potentially rise above 158.

USD/JPY Technical Analysis
After a strong rally from a low of 148.65, USD/JPY has been consolidating just below the 158 level. The price is currently testing support at the 78.6% Fibonacci retracement level at 157.10, with the MACD indicating a bearish crossover.

Key Levels to Watch
Support Level: 157.10
Resistance Level: 158.00
Should sellers break below the 157.10 and 156.75 support levels, a deeper sell-off could occur, targeting the round number at 155 and the 61.8% Fibonacci level at 152.40. Conversely, if the support zone holds, buyers may aim to extend gains above 158.00, pushing towards the 2025 high of 160 and the 2024 high of 162.

Conclusion

In summary, the recent cooling of UK inflation has provided a temporary boost to GBP/USD, while the outlook for USD/JPY remains complex amid hawkish BoJ comments and upcoming US inflation data. Traders should closely monitor key technical levels and economic indicators to navigate these currency pairs effectively. With potential volatility on the horizon, maintaining a strategic approach will be essential for capitalizing on market movements in both GBP/USD and USD/JPY.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.