- GBP/AUD liable to decline on January BoE rate cut says CBA.
- An MPC majority could favour rate cut as soon as January 30.
- Vlieghe, Tenreyro, Carney, Saunders, Haskell all eyeing a cut.
- GBP not priced for move quite so soon so is now vulnerable.
- But RBA also a headwind to AUD and parachute for GBP/AUD.
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The Pound could fall further against the Australian Dollar in the weeks ahead, according to Commonwealth Bank of Australia (CBA).
CBA strategists say in a note out this week the UK currency is liable to further losses agaisnt the Aussie Dollar through to the end of Janaury because the Bank of England (BoE) is likely to cut its interest rate on the 30th and markets are not yet fully prepared for such an outcome. This is after a raft of the BoE's Monetary Policy Committee members hit the speaking circuit from Wednesday last week was arguably an apparent effort to prepare the market for a policy response to recent weak economic figures.
Sterling is the second worst performing major of the last week, behind only the safe-haven Japanese Yen that's been sold by the bucket load as risk appetites recover ahead of Wednesday's anticipated signing of the U.S.-China trade deal.
It's also bottom of the barrel for 2020, although the Pound-to-Australian Dollar exchange rate is down only a fraction for the year-to-date as the bushfires in Australia meant the Aussie Dollar has been itself weighed down by growing expectations for an interest rate cut at the Reserve Bank of Australia (RBA).
Above: Pound Sterling performance relative to major rivals in 2020. Source: Pound Sterling Live.
"The likelihood is the UK economy records a contraction in Q4," says Richard Grace, head of FX strategy at Commonwealth Bank of Australia. "Given the sluggishness in the economy and the transitional headwinds of the Brexit process, we believe the UK economy requires both monetary and fiscal stimulus. We believe the Bank of England will cut rates by 25bp on 30 January."
The Pound has suffered as investors increasingly price-in a possibly imminent interest rate cut from the BoE, with bets against Sterling increasing on Monday after MPC member Gertjan Vlieghe said that he will vote for a rate cut this month in the absence of an “imminent and significant improvement” in UK economic data. This was after outgoing Governor Mark Carney said last week cuts will follow any fresh signs of economic weakness.
"GBP/AUD will decline below 1.8519 if the BoE cut interest rates 25 bp to 0.50% at the end of this month. But GBP/AUD's fall may only be brief. The 30 January BoE meeting is scheduled less than a week ahead of the RBA's 4 February meeting," Grace says. "GBP will depreciate to the 200-day moving-average of 1.2691. GBP/USD is particularly sensitive to UK-US interest rate differentials."
Above: GBP/AUD rate at daily intervals with GB-AU yield differential.
The BoE's Carney claimed the bank can provide 250 basis points of easing in response to a downturn despite Bank Rate being at only 0.75% and also floated the possibility of more quantitative easing. And soon after Silvana Tenreyro also indicated she's now contemplating voting for a cut. That means five of the nine-strong MPC are now potentially willing to cut rates as soon as this month because two others members already voted for a cut back in December.
But the market is unprepared for even one cut to Bank Rate given that pricing in the overnight-index-swap market implied on Tuesday, a January 30 Bank Rate of 0.65%. That's close to the halfway point between the current 0.75% level and the 0.50% that would prevail following a cut and so suggests both upside and downside to Sterling depending on the BoE's actual decision.
"Australian bush fires and drought have slowed economic activity in regional Australia adding to the case for a February RBA rate cut. Indeed we expect a 25bp cut," Grace writes in a note to clients. "OIS pricing for a 4 February RBA rate cut is 11.3bp (or 42.4%). Ironically, this is almost identical to the current pricing for a 30 January Bank of England rate cut, at 11.96bp (or 47.8%).
Above: GBP/AUD rate at weekly intervals with GB-AU yield differential.
Wednesday's inflation and Friday's retail sales numbers will be key in shaping market expectations of the BoE and the pathway trodden by Pound Sterling up ahead. So too will the Tuesday 21 jobs figures and the Friday 24 flash PMI surveys of the UK's three main industries from IHS Markit but arguably the greatest impact on the thinking of the MPC will come from the Wednesday 29 HM Treasury autumn forecast statement.
The latter could bring a fiscal stimulus that might be enough to at least delay a rate cut if economic figures released over the coming weeks are poor. However, the Pound-to-Aussie rate must contend with more than just BoE policy changes because the Reserve Bank of Australia (RBA) will also be in the mix at the same time too. Grace forecasts the RBA will cuts its cash rate to 0.50% next month but the market is also unprepared for that.
"The prospect of both central banks cutting interest rates within a week of each other means the GBP/AUD exchange rate is likely to remain within a tight range, consistent with the Australia-UK one-month OIS spread, " Grace says.
The RBA has cut its cash rate three times in the last year, leaving it at 0.75% and on a par with that of the BoE. Investors had looked until early October for a further two cuts in 2020 but have increasingly reappraised that outlook in favour of less cuts over a longer period, thanks in part to the October 11 U.S.-China trade deal that's set to be signed on Wednesday.
However, the tragic bush fires down under have grown so large and destructive that they've stymied rural activity and redirected significant economic resources toward the effort to contain them. That means rate cuts could now be back on the agenda for the RBA, which might offset some of the anticipated pressure on the Pound-to-Australian Dollar rate in the weeks ahead.
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