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Carney Comments Trigger Pound Sterling Selloff

- Bank ready to cut interest rates

- Comments catch market by surprise

- Sterling is day's biggest loser

Mark Carney impacts the British Pound

Image © Simon Dawson, Bloomberg, Bank of England

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The British Pound turned lower in mid-morning London trade, with analysts citing a combination of potential factors, ensuring the currency's relatively volatile start to 2020 continues.

The Pound fell below the 1.18 handle against the Euro and below 1.31 against the U.S. Dollar, indeed, the Pound is down across the board and is showing losses in value against all the major currencies.

"Sterling is lower. I suggest a combination of Carney latest headlines, EU comment trade deal longer than December & sell flow are all in play and weighing on Sterling," says Neil Jones, Head of FX Sales, Financial Institutions, at Mizuho Bank in London.

Bank of England Governor Mark Carney said in a speech at a Bank of England Research Workshop that the Bank stood ready to deliver a "prompt" response to weakness eyed in the UK economy over recent months; a signal to markets that an imminent interest rate cut could be at hand.

The rule-of-thumb in currency markets is that when a central bank engages in interest rate cuts, the currency it issues loses value. Markets had been expecting an interest rate cut at the Bank of England in 2020, but this had always been dependent on how Brexit played out.

That an agreement has finally been agreed, and will be ratified by the UK Parliament, means a smooth exit will take place in January 2020. There was a growing sense in the market that this could actually see the Bank of England push back any intention to cut interest rates.

However, Carney's intervention appears to have wrong-footed markets, and the Pound is in reverse as a result.

Pound drops vs. Euro

Above: A clear drop in Sterling-Euro exchange rate was recorded on Thursday, January 09.

Carney said there is a debate amongst the Bank's Monetary Policy Committee (MPC) as to the relative merits of near-term stimulus to reinforce the expected recovery in UK growth and inflation.

The Governor, who ends his spell at Threadneedle Street this year, added that the recovery in the UK economy envisaged by Bank economists was by no means assured.

Carney said that with relatively limited space to cut the Bank's interest rate from 0.75%, if evidence builds that the weakness in activity could persist, risk management considerations would favour a "relatively prompt response."

"Currently, there is insufficient conventional policy space based on past experience.... All told, a reasonable judgement is that the combined conventional and unconventional policy space is in the neighbourhood of the 250 basis points cut to Bank Rate seen in pre-crisis easing cycles," said Carney.

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Why Weakness Might be Limited

The intervention of Carney in this manner is surprising in that it comes just as hints emerge that the economy picked up strength in the wake of the December General election.

This week's Services PMI release showed that firms reflected an increased level in confidence on the outlook following the decisive win for the Conservatives, while Halifax house price data showed UK house prices posted their strongest monthly increase in nearly 13 years in December with a +1.7% month-on-month, taking the year-on-year increase to 4%.

Anecodatal evidence suggested that there was an almost instant pickup in interest in the housing market following the election result.

Of course there is no 'hard' data reflecting any post-election bounce in the eonomy, but if a pickup is registered in data in the first quarter of 2020, the Bank of England will find it difficult to justify why the UK economy requires an interest rate cut.

The Pound would find itself supported under a scenario where the Bank rows back from its 'dovish' stand and starts pointing to signs of improvement.

"Nothing has changed," says Viraj Patel, FX & Global Macro Strategist at Arkera. "UK data & prevailing Brexit politics will drive policy (both better). Bar is high for a BoE cut given limited policy space (whole premise of Carney's speech). GBP/USD attractive at 1.30."

 

Trade Negotiations Offer Sterling Some Positives

von der leyen and johnson

Above: Boris Johnson greets Ursula von der Leyen on the steps of 10 Downing Street, Wed. Jan. 09. Image courtesy of 10 Downing Street, Gov.uk.

The British Pound started the day being well supported after European Commission President Ursula von der Leyen told an audience in London that the EU and UK would have to prioritise those elements of a trade deal they feel could be achieved by the end of 2020, even if the full package could not be agreed in time.

The short-hand interpretation being that the full future trading relationship could be realised through phases, meaning the Pound won't have a 'cliff-edge' to worry about at the end of the year.

"The more divergence there is, the more distant the partnership has to be. And without an extension of the transition period beyond 2020, you cannot expect to agree on every single aspect of our new partnership. We will have to prioritise," said von der Leyen.

The Withdrawal Agreement talks that have taken place over the past three years were conducted under a 'nothing is agreed, until everything is agreed' format. The lows hit by Sterling over the course of the past three years tended to occur when the market was concerned that the UK would leave the EU without a deal because one or two nagging issues were holding back the entire deal.

von der Leyen's comments strongly suggest there will be no 'cliff edge' scenario facing the EU and UK if both sides fail to agree a full trade package by December, and it therefore makes talk of a 'no deal' Brexit virtually redundant. The risks to the UK economy and therefore the British Pound are greatly reduced by this stance.

The Pound-to-Euro exchange rate rose to 1.18 on Thursday morning, and in doing so kept alive a broader medium-term trend that has been in place since August 2019, even considering the Carney-inspired drop, the Pound remains poised for further advances from a technical perspective:

Pound maintains uptrend vs. the Euro

Above: GBP/EUR remains in an uptrend.

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If the agreement on a future trade relationshipcan be staggered then the prospect of severe economic disruption resulting from any sticking points is minimised, while Prime Minister Boris Johnson can still keep his promise of not extending the transition period. "A disruptive outcome is not a certainty. Some kind of agreement may be possible by the end of the year, perhaps which covers most trade in goods, but leaves thornier issues for later," says Oliver Allen, an economist with Capital Economics. "We think the easing of at least some uncertainty could yet provide a bit more upside for both the economy, and the Pound."

Johnson has refused to extend the negotiating period for a trade deal to beyond year-end, thereby putting immense pressure on both sides to seek a solution in less than 12 months. Trade negotiations are only likely to begin at some point after February, as the EU is yet to deliver its negotiating team, lead by Michel Barnier, with a mandate. "In London I met Boris Johnson & looked at the year ahead: negotiating a new partnership but, as the President said, it will not be as close as now. Time is short. A new clock is ticking. Our focus is implementing the Withdrawal Agreement & preparing negotiations on EU side," said Barnier, who travelled with von der Leyen to London on Wednesday.

The negotiations should prove challening as the UK wants to diverge from the EU on a number of fronts, with question of fishing rights being an obvious flashpoint while the future role of the European Court of Justice will prove to be another.

Foreign exchange markets will take guidance from trade talks in 2020, and we expect the Pound to be reactive to progress, or lack of progress. "While we forecast that the pound will strengthen a touch this year, we think that the uncertainty surrounding a UK- EU trade deal will stop it from going to the races," says Allen.

However, what is becoming clear is that this is fast becoming a story for later in the year when the deadline is nearing.

The first half of 2020 could therefore see the Pound start taking more direction from the domestic economy, Bank of England interest rate decisions and crucially, the March budget.

Marc André Fongern, Head of FX Research at MAF Global Forex is bullish on Sterling's prospects over coming months:

"Basically, the UK pound is a sleeping giant, whose reputation has been significantly battered. It may be a fallacy to price in a no-deal scenario prematurely. The EU-UK trade negotiations aren't necessarily doomed to failure. Parliamentary arithmetic should hardly weigh on the pound sterling in 2020, i.e. against the background of reduced political risks, I expect a fundamental recovery of both the UK currency and the domestic economy."

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