GBP loses its mojo as UK recovery slows

The cost of holidays for Britons escaping the winter could become more expensive as a slowdown in domestic economic growth pushes out the Bank of England interest rate hike expectations further out, weighing on the pound.

The latest data suggests activity in the key services sector slowed down to an almost 2 and a half year low at the end of third quarter, according to a closely-followed Purchasing Managers’ Index (PMI) compiled by Markit. The PMI printed 53.3 for the month of September, disappointing expectations of a 56.6 reading and down sharply from 55.6 in August.

Although the UK economy expanded at a decent rate of growth of 0.7% in the second quarter, Markit thinks the GDP grew by 0.5% in the third and is likely to expand just 0.3% in the final quarter of the year.

The disappointing services data comes after a lacklustre performance from the manufacturing sector, whose PMI eased to 51.5, though the construction PMI improved sharply to 59.9 in September from 57.3 in August. Construction in the UK continues to thrive amid record low interest rate and high demand for homes.

If the soft patch in UK data continues, the pound could fall sharply especially against currencies which have heavily under-performed in recent times and where interest rates are relatively higher than in the UK.

The Australian dollar could be one of those currencies, which has found some support over the past couple of weeks due to a less dovish-than-expected Reserve Bank of Australia (RBA) and rebounding commodity prices.

In fact, the RBA looks set to keep interest rates at a record low level of 2% tomorrow, which may again disappoint those who have been expecting further cuts since the start of the summer and therefore give the AUD a further lift.

Technical outlook: GBP/AUD

If the above view comes to fruition then the GBP/AUD could move sharply lower over the coming days and weeks for it also appears to be on the verge of a technical breakdown. As can be seen from the chart, below, the multi-year rally has recently lost steam around the 61.8% Fibonacci retracement level of the entire 2008-2013 downswing, at just shy of 2.2100.  Price spiked through this level upon the first test, but was then rejected immediately by the bears and this reaction caused price to create a Gravestone doji candlestick formation on its weekly chart (see the inset).  This particular candle is formed when the opening, low, and closing prices are all at about the same level.  There is also a long upper shadow present in the candle which indicates a potential turning point as price tests supply and finds resistance there. The GBP/AUD has since had a couple of unsuccessful attempts to break through this area, leading to further unwinding of long positions.

In addition to the weekly Gravestone doji candlestick formation, there is also a descending triangle pattern clearly visible on the daily chart. These particular triangles tend to be more bearish than the regular one as by definition price has to at least form some lower highs if not lower lows for this pattern to be formed. The lower highs suggest the selling pressure is increasing as time elapses without seeing a higher high.

The base of the above-mentioned triangle and candlestick formation are around 2.1400, which is being tested at the time of this writing. A decisive break below here could see price drop initially towards the 100-day moving average at 2.0965 ahead of the next horizontal support at 2.0875 next. But the selling could potentially go far beyond this level over time given the importance of this potentially bearish setup.

This bearish view would become invalid upon a break above the resistance trend of the triangle pattern around 2.1730. If this happens, price may go for another test of the long-term 61.8% Fibonacci level before makings next move.