Austere Trouble Brewing For The British Pound

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Just a few days after writing that the U.S. dollar's post-QE3 rally was giving way to meandering, the U.S. dollar (NYSEARCA:UUP) surged back to the top of the recent relief rally range and closed at its highest post-QE3 level to-date.

The U.S. dollar index surges to its highest post-QE3 levels

For now, I am expecting overhead resistance at the declining 50-day moving average (DMA) and the flattening 200DMA to hold. However, the recent breakdown of crosses with the likes of the British pound (NYSEARCA:FXB) will make this call a close one. Trouble seems to be brewing for the British pound as it has declined against the U.S. dollar ever since failing to overcome resistance around the 1.63 level which is the 2012 high from April. Over the past four trading days, this decline has accelerated into a retest of the 50DMA support. A break through this level should confirm that the British pound's rally has essentially ended for the short-term.

The pound continues to break down

The British pound has also started to break down against the yen (NYSEARCA:FXY) although the uptrend from historic lows remains well intact.

With a break below the 50DMA, the pound looks set to eventually retest the uptrend from historic lows against the yen

Source for charts:

Likely weighing on the pound is recent news that the UK government is likely to extend its forecast for austerity through 2018. This stretches the austerity plan from the five years projected in 2010 to eight years. George Osborne, the UK Finance Minister put a good face on the news by stating:

…Britain is a country that is tackling its problems head on…We've got a credible plan to reduce our budget deficit that's delivering very low interest rates for us in the markets at the moment. So that is the proof there's international confidence in our plan.

Of course, when monetary authorities are manipulating rates lower, it is hard to use them as an indicative signal. Moreover, interest rates are also very low in the United States where an austerity budget is nowhere to be seen. Instead, what is likely happening in the United Kingdom is that slower growth than forecast is leading to lower than expected revenues for the government leading to the need for yet more budget cuts. Ironically, the UK dipped back into recession earlier this year despite generating "a million jobs over the past couple of years." The decoupling of job growth and economic growth creates uncertainty about what kind of growth the U.K. can expect going forward.

This extension of lean years is sure to test the nation's resolve to try to cut its way to prosperity. It is interesting, and not unexpected, that the government's response to austerity's failure is to prescribe more austerity. According to Reuters, the Conservative party must stick to the austerity remedy and cannot afford to admitting a mistake. The debate amongst competing parties resembles closely the debate in the U.S. about the proper balance of tax hikes and spending cuts to address the deficit.

Regardless, if the growth differential continues to widen between the U.S. and the U.K., I expect the British pound to face increasing downward pressure. I changed by bullish stance to neutral after the British pound tested and failed to break through the 1.63 level. This latest break down now changes my stance to mildly bearish, meaning that if I trade the currency, my bias will be to look for opportunities to short it. However, I see no need yet to get aggressive with such trades.

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I may trade long or short at any time.