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Bank of England: Three Scenarios that will Shake British Pound, Euro and US Dollar
The focus of the week for Pound Sterling is Thursday's Bank of England latest policy decision and release of forecasts for inflation and economic growth.
GBP is at a two-week high against the US Dollar just 24 hours beforethe Bank of England's super-Thursday event.
Mark Carney will be the centre of attention for the second time this week when he delivers his Bank of England’s latest growth and inflation estimates.
The Bank will also release the decision of the Monetary Policy Committee on whether or not to cut the interest rate.
Most analysts are not expecting another cut owing to the recent outperformance in UK economic data, but guidance will be key.
Are there more interest rate cuts in the future, or will the next move actually be to raise interest rates to defend Sterling and stave off higher inflation?
The day could therefore have implications for Pound Sterling which continues to form a base against the Euro and Dollar but remains susceptible to further weakness.
Analyst at TD Securities say their base-case scenario is for a 20bps cut to Bank Rate, leaving them in the minority of analysts as the vast majority (more than 90%) are looking for rates on hold.
If TD Securities are correct then you can bet Pound Sterling will fall notably against the Euro and US Dollar.
“The key question will be whether the outlook is still judged to be “broadly consistent” with the August Inflation Report projections, as that was the necessary and sufficient condition given for further easing this year,” say TD Securities.
On such a scenario the Pound / Dollar exchange rate is forecast to fall to 1.2080.
The Euro / Pound Sterling exchange rate could rise to 0.9175.
There are however other scenarios that could play out, one being a “dovish pause” which TD Securities describe as being a decision to leave interest rates unchanged but the BoE signals a strong desire to cut interest rates again on signs growth is slowing.
On such a scenario the GBP/USD is forecast to trade at 1.2190 and EUR/GBP at 0.91 - close to, but still lower than, current levels.
A third scenario is a “hawkish pause” - this is where TD Securities see no more than 1-2 MPC members vote for an interest rate cut.
The accompanying message is that Brexit did not have the negative impact that was expected and the impact to medium-term is very uncertain,
“More concerns about overshoot to inflation and ability of business to adjust to GBP volatility,” would be conveyed say TD Securities.
Analysts say that in such a scenario we could see GBP/USD rise to 1.2470 and EUR/GBP fall to 0.88.
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British Pound Up as Government Loses Article 50 Case, Ruling Opens Door to More Unwelcome Uncertainty
Brexit is back on the agenda for Pound Sterling on Thursday November 3rd as the High Court rules in favour of those seeking to challenge the Government's ability to trigger Article 50 without the approval of Parliament.
The Pound rallied on news that the UK Government is unable to trigger Article 50 of the Lisbon Treaty without the approval of Parliament.
Sterling, already higher on stronger-than-forecast economic data, extended its gains across the board.
However, we note the spike didn't last long because there is one big implication of the ruling - more uncertainty.
What's more, the Government is expected to appeal the decision which means we will go through the whole process again.
The first senior Government response to the ruling comes from International Trade Secretary Liam Fox who tells Parliament the government is "disappointed" by the ruling and that the "country voted to leave" in a referendum sanctioned by Parliament.
He says the "government is determined to respect the result" and will "consider it [the judgement] carefully".
The Pound jumped but Stephanie Flanders at JPMorganAsset Management's Chief Market Strategist rightly points out that it would be wrong to assume Sterling continues rising from here:
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GBP: Targets For N-Term Path After UK Court Decision
We have been thinking about the near-term path for the British Pound in terms of two things.
First, there is the question where GBP/$ would trade in the event of “hard Brexit”. In recent weeks, we have used a number of approaches to show that Sterling could fall between 20-40 percent relative to pre-referendum levels, with a base for GBP/$ to reach 1.10
Second, there is the question what probability to assign to “hard Brexit”. In our minds, it has been this probability that has been moving the Pound around in recent weeks. In particular, the political vacuum following the referendum meant that there was some probability that Article 50 might never be triggered. In the presence of large speculative shorts, this kept the Pound supported after its initial referendum fall. But the conservative party conference changed that, with Prime Minster May committing to trigger Article 50 by March. We thought the market would price a greater probability of “hard Brexit” as a result, reiterating our near-term target of 1.20 for Cable in the days just after the conservative party conference.
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Game-Changer Week for British Pound Against Euro and Dollar, Expect Volatility to Rise Next Week on US Elections
Sterling retains a strong bid against most of its G10 peers into the weekend with the final potential pitfall of the week - US employment data - being successfully negotiated.
The Pound to Dollar exchange rate trades at 1.2506 at the time of writing having started the week at 1.2178.
The Pound to Euro exchange rate trades at 1.1256 having started the week at 1.1079.
“A game change of a week for Sterling had it up around 2.5% and on pace for its best since March,” says Joe Manimbo at Western Union. “The short-run game for the pound changed for the better after the risk of an economy-choking hard-Brexit receded after the U.K. High court ruled that Parliament would have to approve the government’s Brexit plan.”
The Bank of England further aided Sterling after shifting its policy bias into neutral from rate-cutting mode, while it also helped Sterling sentiment that Governor Mark Carney agreed to stay 12 months longer until mid-2019, offering a welcome sense of continuity as the country navigates its exit from the European Union.
“The pound has had an exceptional week in the light of a series of political events relating to Brexit and the economy,” says Paresh Davdra, CEO and Co-Founder of RationalFX.
A big pop higher was delivered on Thursday October 3rd when the Bank of England surprised markets by notably upgrading their growth forecasts for the UK economy.
The Bank also communicated they they do not see further interest rate cuts as being likely with market pricing going so far as suggesting the next move could be to actually raise interest rates.
Expectations for higher interest rates tend to be supportive of currencies.
Sterling also benefitted on the US Dollar’s woes stemming from Donald Trump’s better performance in the US election polls which unsettled investors.
America goes to the polls on the 8th November and, “if this week is any indication, the culmination of the US elections and uncertainty over who the next President might be could prove to be beneficial for the pound in the immediate future,” says Davdra.
It is too early to say how a victory for either side will influence foreign exchange markets but we would warn that volatility is highly likely.
"The polls continue to tighten and we see the risk that following payrolls market liquidity dries up, as market participants await for Tuesday’s election results. Reduced liquidity is likely to inject greater dispersion in the price action," says Mark McCormick at TD Securities.
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Bank of England Slips into Neutral and the Pound Leaps
Pound Sterling hit its best levels against a number of G10 currencies after the Bank of England votes unanimously to keep interest rates unchanged and upgrade their growth forecasts.
Pound Sterling charged higher as soon as the news was announced that the Bank of England's Monetary Policy Committee had voted unanimously to keep interest rates unchanged at 0.25%.
There were some expectations for a split in the vote and the outcome betrays a Bank whose next move may actually be to raise interest rates.
This is positive for the Pound as it hints at greater capital inflows into the UK from foreign investors seeking yield.
Also helping Sterling was the upgrade to growth forecasts in the Inflation Report.
Raising its growth forecast for 2017 to 1.4% from 0.8% makes this a record upward revision to a growth forecast.
The Bank of England conceded a massive miss on their previous GDP forecasts owing to them being too pessimistic on the outlook for the UK economy following the Brexit vote.
Of note, the consumer confidence of the UK consumer surprised the Bank as, “households look entirely through Brexit uncertainty.”
Governor Carney says business investment has been better than the Bank had initially forecast.
Inflation forecasts are lifted to 2.75 from 2% in 2017 and to 2.7% from 2.4% in 2018 thanks almost exclusively to the fall in value of Sterling.
The fall in Sterling will have more significant implications for monetary policy as it raises inflation forecasts over the next three years.
With inflation clearly heading above the mandated 2% we could expect an interest rate rise in coming years, but not too soon as Carney says the impact of the weaker exchange rate should be temporary in nature.
The irony though is that because Carney speaks about higher inflation so the Pound rises. This in turn lowers prospects for inflation down the road, the question is how much further can Sterling recover?
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GBP: A Recovery Towards 1.28/130 'Feasible' But Hesitant To Get Bullish Here
The High Court’s decision that Parliament needs to support Article 50 before the government can trigger it is about the process of leaving the EU and in no way challenges the referendum’s decision to leave. Should the Supreme Court uphold the High Court’s decision, the government would have to bring in a new law, voted on in Parliament, to leave the EU. That could be subject to much debate over what Brexit will look like in both the House of Commons and House of Lords and it could delay PM Theresa May’s plan to trigger Article 50 before the end of March 2017. Needless to say, if the Supreme Court overturns the High Court’s decision, expectations of a hard Brexit will spring back.
In the short term, therefore, the political situation is something of a vacuum and some scaling back of hard Brexit-related bearishness towards the sterling may be prudent over the coming weeks. Sterling’s most recent slide started in early October as the Conservative Party conference got underway. Sterling was trading just below 1.30 vs USD back then, so a recovery towards a 1.28-1.30 range is feasible, and possibly more likely if the Supreme Court upholds the High Court’s decision.
That was premised largely on the view that the hard Brexit story was largely discounted based on available information and recent political rhetoric. We also anticipated that the BoE was likely to revise up its inflation forecasts in the November Inflation Report and that the case for additional easing in the near term was not there. What we did not know a couple of weeks ago was what the ruling of the High Court would be.
Therefore, our expectation that sterling would trade in a 1.20- 1.25 range over the next six months or so might be vulnerable to a more sustained topside break driven by expectations of potentially greater balance returning to the Brexit debate. We therefore see upside risks to our current sterling forecasts of 1.25-1.30 vs USD in the coming months, but would be hesitant to get more bullish that that until the political and legal framework becomes clearer.
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