Thursday, October 6, 2022

Can The Pound Sterling Recover?


The Bank of England (BoE) has defied market expectations by interest rates by 50bps at its September meeting. Implied pricing showed that market participants were skewed towards a bigger 75bps hike, especially after BoE Governor Andrew Bailey had used the term “forcefully” when referring to the BoE’s need to combat high and persistent at the previous meeting. This word has also been repeated in this week’s statement, but still, the bank has deemed that 50bps is enough.

Actually, no. The BoE, as a whole, doesn’t see it that way. Three of the nine voting members have lobbied for 75bps at this meeting, but they lost out to the majority. These members were, of course, the ones perceived to be more hawkish: Ramsden, Haskel, and Mann, which is no surprise. Another member voted for a smaller 25bps hike which is slightly surprising and may have confused markets given the current levels.

The updated projections from the BoE suggest inflation peaking at 11% in October, a drop from the 13.3% predicted at the meeting in August. Still, it suggests CPI may continue to rise over the coming months. The fact the BoE assumes inflation may remain above 10% for the foreseeable future, and yet they continue on their cautionary path of rate hikes, is what might fuel the continued sell-off in the (GBP).

This is because the UK economy is at a greater risk of stagflation than the US. This term defines a period of high inflation and stagnant growth. With the BoE predicting a recession over the next five quarters, the projected inflation rate implies the UK economy could be in for some turmoil up ahead.

Compare this to the US, where there is persistently high as well, but the Federal Reserve has been acting more forcefully to combat this issue. This alone gives the a competitive advantage against the pound. Add on to that the market sentiment is worsening given the escalation in tensions in Eastern Europe, and you get further demand for the dollar as a safe-haven asset.

For now, GBP/USD is holding above this week’s lows, but the technical setup suggests further downside pressure, with a firm focus on the historical lows for the pair around 1.0512, last seen in 1985.

Markets may start to evidence that the three BoE dissidents are correct, and the bank could have put its foot down even harder on the hiking pedal. Unless concerns about the looming recession become more important than inflation, at which point the gradual rate hikes the BoE has been delivering make more sense— and might mean the pound is in a better position for recovery than its major counterparts.

Only the upcoming data may be able to shed some light on which side of the spectrum market participants will fall.

Disclaimer: This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of or any of its affiliates, subsidiaries, officers, or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds. Past performance is no guarantee of future results.

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