Pound to Dollar - and Euro, weaken, after Bank of England Paints Unforgiving Picture of Post Brexit World

[thenews]

 At its June rate meeting Bank of England members stressed the risks not only to the UK economy but the world financial system of breaking away from our European cousins

 The pound fell against most counterparts on Thursday after more warnings from the Bank of England about the consequences of a break with Europe. 

 

The comments about the impact of a Brexit were in the statement and minutes of the the Bank of England's (BOE's) monthly policy meeting, at which base lending rates for the whole of the UK financial sector are decided.

 

They revealed deep concerns about how the economy would be hit by a decision to leave the European Union (EU), saying such a shock would impact not just on the UK economy but also potentially the global economy.

 

"The outcome of the referendum continues to be the largest immediate risk facing UK financial markets, and possibly also global financial markets."  Said the BOE's meeting statement.

 

At the meeting BOE members underlined how growth would be compromised by a vote to leave, saying:

 

"A vote to leave the EU could materially alter the outlook for output and inflation, and therefore the appropriate setting of monetary policy. Households could defer consumption and firms delay investment, lowering labour demand and causing unemployment to rise.. At the same time, supply growth is likely to be lower over the forecast period, reflecting slower capital accumulation and the need to reallocate resources."

 

Monetary policy left alone

 Investors had not been expecting any change in policy from the BOE due to the closeness of the EU referendum on June 23, (only seven days away), and they were right.

 

The BOE voted unanimously to keep the base lending rate, or Bank Rate, at 0.5% and asset purchases at 375bn pounds.

 

The minutes of the meeting suggested inflation was still far too low at 0.3% to consider raising rates, given the BOE's target of 2.0%.

 

The BOE said it still saw inflation rising slowly at the rate outlined in its previous May Inflation report.

 

Nevertheless, inflation was expected to rise to the target over two years, and at that point Bank Rate was expected to be higher than its current level.

 

The statement added that further rises in Bank Rate would probably be more gradual than previously expected due to domestic and global "headwinds".

 

"The MPC judges that it is more likely than not that Bank Rate will need to be higher by the end of the forecast period than at present to ensure inflation returns to the target in a sustainable manner.  All members agree that, given the likely persistence of the headwinds weighing on the economy, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles. "

 

The statement and minutes also alluded to the already tangible impact of the EU referendum on businesses and growth, arguing that the uncertainty caused by the vote was delaying decision making in key business sectors:

 

"While consumer spending has been solid, there is growing evidence that uncertainty about the referendum is leading to delays to major economic decisions that are costly to reverse, including commercial and residential real estate transactions, car purchases, and business investment."

 

The minutes also outlined the contingency measures the bank would take in the case of a victory for the leave vote, which broadly involved the provision of sufficient liquidity, including foreign exchange, to banks and other financial institutions, as well the maintenance of foreign credit channels.

 

Unicredit's Senior UK Economist Daniel Vernazza said the June BOE meeting had not changed their base case scenario that the BOE would raise interest rates in November, following a victory for 'Remain'.

 

He also suggested an alternative outlook in the case of a Brexit, which was that the BOE would cut the Bank Rate to zero (from the current 0.5%) to help support growth.

 

This would be the case despite an expected rise in inflation resulting from a sudden sharp drop in the value of sterling, making imports more expensive.

 

The BOE themselves alluded to the fact in a hypothetical post-brexit world they would have a catch-22 dilemma, familiar to emerging market economies, of whether to choose between 'growth-friendly' low interest rates or to battle rising inflation at the cost of growth by raising interest rates.

 

"This combination of influences on demand, supply and the exchange rate could lead to a materially lower path for growth and a notably higher path for inflation than in the central projections set out in the May Inflation Report.  In such circumstances, the MPC would face a trade-off between stabilising inflation on the one hand and output and employment on the other." (BOE June Statement).

 

Polls still too close to call, bookmakers still backing 'Stay'

 

In a note in response to the BOE meeting the broker TD Securities, included a report on the latest poll results.

 

"Two new telephone polls released today continue to point to a very tight race. While Leave appears to have pulled ahead in recent days in the majority of both phone and online polls, betting markets still expect that Remain will ultimately win. A few historical facts support this view."

 

They point out that it appears to be a common phenomenon that the non-status quo vote surges  in the three weeks prior to the vote but that on the day people usually vote for the safer status quo option.

 

"In the 1975, 1979, 1997 (x2), 2011, and 2014 referendums in the UK, support for the "non-status quo" side surged about 1 to 3 weeks prior to the vote, but the status quo prevailed as voters decided to take the less risky option."

 

What charts are showing - GBP/USD now bearish

 

The GBP/USD chart is currently the most interesting, as it is showing a break below a major support level which has increased the bearishness of the technical outlook.

 

The pound to dollar has now broken below the 1.4140-50 support area, provided by the 'neck-line' (blue line) of an inverse head and shoulders bottom pattern.

 

It has now also breached the 1.4089 lows formed on June 14 - forming a new low at 1.4013. The 1.4089 level will probably now act as resistance and cap any rebounds.

 

The MACD indicator, which measures momentum, has fallen below the the zero line indicating the start of a bearish trend.

 

Overall the odds seem stacked, therefore in favour of more downside.

 

Most analysts agree that 1.4000 is key and that as long as the exchange rate remains above 1.4000 there is an improved chance of a rebound, however, a move below the 1.3990 level would probably indicate a continuation to 1.3850, just above the February lows.

 

The chart of the EUR/GBP pair, meanwhile is showing the formation of an "evening doji star" appears to be warning of possible pull-back on the horizon.

 

The pair has also reached the minimum expected target following the breakout above a major trend-line/out of a channel at 0.7790.

 

Formidable support at 0.7900, however, is likely to cap any losses.

 

A clear break above 0.8000 -  denoted by a move above 0.8040 would probably indicate a continuation up to the 0.8100 level, at just below the 0.8117 peak.

 

Commerzbank's Karen Jones, sees the pair as "bid", suggesting the 0.7998 Fibonacci retracement (0.786%) presents a last line of defence before the 0.8117 peak.

 

Lloyds's Robin Wilkins is similarly bullish:

 

"Risks remain to the upside after breaking 0.7947 resistance. UK versus European bond spreads are breaking levels that support further gains in this cross-rate, but so far we are still holding resistance at 0.7990/0.80. A break is needed to open a move back to the 0.8117/0.8200 key long-term resistance."

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