Image © Bank of England
The British Pound has fallen as the market scales back its expectations for another Bank of England interest rate hike tomorrow, but given the scale of recent declines, the odds of a rebound are growing.
The market has been selling Sterling for a month now, with losses accelerating in the wake of UK inflation data released midweek, leaving the currency technically oversold on some crosses and at the bottom of a well-defined and sturdy summer range against the Euro.
Some relief could be in store.
"On the back of the much softer than expected print for UK August CPI inflation this morning, the market is pricing in a significantly lower chance of a BoE rate hike tomorrow," says Jane Foley, Senior FX Strategist at Rabobank.
Rabobank joins the consensus in expecting the Bank to deliver a further 25 basis point hike on Thursday, although it acknowledges the odds of a pause have risen.
"GBP lurched lower in the immediate aftermath of the data this morning as perceived risks regarding the outlook for policy tightening altered," says Foley.
The Pound has now fallen 1.80% from its August high at 1.1775 with much of the decline reflecting a sharp repricing lower in Bank Rate expectations. Looking ahead, what will matter is the extent to which this repricing can continue.
With expectations having adjusted sharply, the bandwidth available to the Bank to deliver 'dovish' guidance and decisions that can push the Pound to fresh lows is diminished.
A rebound therefore becomes more likely if the Bank can convince the markets it can, and will, hold interest rates unchanged for a prolonged period.
What could prove effective in this regard is skipping a September hike by clearly guiding towards a November move. This strategy has been deployed by the Federal Reserve and has proven successful in keeping interest rate expectations elevated across the multi-month outlook period.
The Bank could also raise rates and maintain recent guidance that keeps the door open to a November hike, saying more evidence on falling services inflation and softening wage dynamics is required to end the cycle.
Falling inflation can meanwhile be considered a supportive development for hard-pressed UK consumers and businesses which can shore up the UK's economic prospects.
These prospects are improved further by the likelihood of the Bank being able to soon end its hiking cycle.
"On the view that the BoE may need to hike less than had been expected, the chances that the BoE will push the UK economy into recession have also dropped. Relief that the UK growth outlook may be a little better than it could have been, should allow GBP a little support," says Foley.
Ahead of the decision the GBP to EUR conversion is testing its lowest level since August 11 at 1.1565, which places it at the bottom of the summer range:
Above: GBPEUR can look for support towards the bottom of the summer range.
From a technical perspective, the odds of a rebound are growing notably given there appears little in the fundamental story to justify the pair breaking out to either the downside or upside.
Upside odds are aided by the above-mentioned factors, although Bank of England watchers will be well aware of the Bank's preference for leaning on the 'dovish' side of the messaging spectrum, particularly during 2023.
This raises the risk the Bank sends a clear signal that Thursday's hike is the final move and that the odds of a further rate hike are limited. Such communication could encourage the market to bet on an earlier rate cut in 2024 which can weigh heavily on Pound Sterling.
Analysts at Goldman Sachs have limited confidence in the Bank's ability to strike the kind of tone required to support the Pound.
"In order to see greater Sterling strength, we think that the cyclical picture in Europe needs to improve, and the Bank of England needs to pursue a more hawkish policy path. Unfortunately, neither of those seem likely to shift in the near-term, meaning that a flattish EUR/GBP could persist for longer," says a note from Goldman Sachs.
Analysts at HSBC are equally pessimistic on the Pound's bullish prospects heading into Thursday.
"A rate hike would not be definitively positive for GBP, especially if the BoE signals that this is the last one and it adds to the gloomy thinking about growth. We view GBP as being in a bind," says Paul Mackel, Global Head of FX Research at HSBC.