GBP Parity after BOE intervention?

Turmoil has hit UK markets since the announcement of the new Chancellor’s mini budget. Could the pound be heading for parity vs the dollar?
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Intervention

On Wednesday the BOE announced that it would begin intervening in the UK bond market, buying up long-dated gilts to stabilise interest rates. as investors in long-term debt were facing the potential of margin calls. This creates an unusual scenario where the central bank is both buying (QE) and selling (QT) bonds at the same time, in an unorthodox approach to yield curve Control.

With the pound at historic lows against its peers, contributing to already exacerbated inflationary pressure, there is talk that the next step from the BOE might be step in to strengthen the currency. Something similar to what the BOJ did last week. However, the BOE has a lack of ammunition. The BOE only has around $86.8B in foreign reserves, making a foray into the market with a daily transaction volume over $1.0B somewhat ineffectual.

The BOE could strengthen the pound by raising rates, but that would come at the cost of increasing the risk of a recession. Kwarteng's budget is seen as a gamble to get the economy going and control inflation from the other end: increasing production. The issue for cable is that the BOE and traders can't gamble on the plan working. This would likely keep downward pressure on the pound, particularly if last quarter's GDP is not revised a decimal or two.

GBP Preview

Preliminary UK Q2 figures released in mid-August showed negative growth by the bare minimum: -0.1%, compared to -0.2% expected. Economists expect tomorrow's figures to be in line with forecasts of -0.1%, negative for a consecutive time. Some are wondering if Q2 data will be the start of the recession.

Of course, the potential for recession is one of the explanations for the weaker pound. The other is the tax and energy program announced by Kwarteng last week. Many traders see it as increasing spending and cutting income, which would shake confidence in the country's finances. It could cause additional inflationary pressures but simultaneously curtail action by the BOE, as the central bank would have to respond to the coming (if not already arrived) recession.

Pinbar in the spotlight

Cable remains volatile following the flash crash to 1.0328 due to the solid reversal to 1.0800. The low at the 138.2% Fibonacci of the 1.1411-1.4243 leg is critical to the pound's medium-term outlook. If lost, Sterling will be paving its way to parity.

However, closing the week close to where the pair opened Monday leaves a decent pin bar on the charts. Increasing momentum will support the case of a full-blown reversal should prices move back inside the base channel. The breakout can be observed at around 1.1292, with 1.1350 being the high-momentum bearish bar open and 1.1411 a resistance bulls must flip.

Key takeaways

The pound has been weakening due to a potential recession and the tax and energy program announced by Kwarteng. UK economy saw negative growth during Q2, and some wonder if the recession is already here.

To make things worse, the BOE is unlikely to intervene by buying pounds due to limited foreign reserves, but it announced buying bonds to stabilise the market. The other choice is to raise interest rates, increasing recession risks and keeping downward pressure on the pound.