GBP Rallies Despite Fitch Credit Downgrade

UK Under Pressure

In the latest development to highlight the severity of the economic damage being caused by the ongoing coronavirus outbreak, rating agency Fitch has downgraded the UK’s credit rating from AA to AA-.

This is the latest in a series of downgrades from Fitch over recent years. It started in 2016 when the UK was downgraded to AA. This came following the unexpected Brexit referendum result. In February 2019, Fitch then put the UK on negative watch. This was due to the economic damage caused by Brexit uncertainty as negotiations stumbled on.

Fitch Was Concerned Before Coronavirus Crisis

Given the sharp repercussions from the coronavirus outbreak, the announcement by Fitch won’t come as too much of a surprise to many. What is interesting though are the reasons they include. Much of the commentary released with the decision refers to the damage from coronavirus. However, Fitch also highlights pre-coronavirus weaknesses in the UK economy as the main factors which fuelled a change in outlook.

Fitch noted that “timely and targeted” policies to counter the crisis were appropriate. Here they are referring to BOE rate cuts and QE. However, Fitch expressed concern over the UK government’s handling of the situation. He is referring specifically to the widening of the budget deficit. Fitch notes that it is not convinced that once the crisis passes, the government will be able to shrink the deficit and new debt accrued.

Trade Talks Creating Uncertainty

On the other hand, Fitch did note that some increases in investment spending could be beneficial for productivity and growth. Despite some positive signs, however, Fitch’s outlook was mostly bleak with the agency also noting the negative impact of trade deal uncertainty. With EU/UK trade talks side-lined while the UK and EU leaders combat the coronavirus crisis, there is a growing fear that the UK will walk away from talks at year-end without a deal being achieved. The UK PM is so far yet to change his position on his refusal to extend the deadline for the talks.

Despite news of the downgrade, GBP remains well supported this week. This comes following a strong rally last week in response to the BOE’s latest policy adjustment. With rates at record lows of 0.10% and with the BOE having approved £200 billion in QE, the sell-off in GBP has stalled for now.

GBPUSD Bullish Reversal Risks

Looking at GBPUSD on the monthly chart we can see an interesting setup. Price has been moving in a large descending triangle over the last five years, underpinned by the 1.1929 support level. Following a break below this level earlier in the month, price has since reversed sharply and is now back above that level.

The RSI indicator has highlighted clear bullish divergence on the last two tests of that level. While price holds above the 1.1929 level, the downside move can be viewed as a false break. This is putting focus on the potential for a reversal higher in the medium-long term.