- UK economy shrank 0.3% in November
- Momentum now pitted against Sterling
- Expectations for interest rate cut intensify
- But, all hinges on economic survey data following Dec. election
Image: Above Bank of England Gertjan Vlieghe.
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The British Pound was trading in the red against the Euro, U.S. Dollar and other major currencies at the start of the new week, with foreign exchange analysts saying the weakness can be linked to building expectations for an imminent Bank of England interest rate cut owing to signs of a sharp slowdown in UK economic activity in 2019.
Over the weekend Bank of England Monetary Policy Committee (MPC) member Gertjan Vlieghe said he would vote to cut the cost of borrowing for the first time since 2016 if economic data released later this month shows that performance remains sluggish. Vlieghe's comments meanwhile appear to have foreshadowed a dire set of economic statistics out on Monday.
GDP data for November - out on Monday morning - showed that the UK economy contracted 0.3% that month. The ONS also reports that manufacturing production slumped 1.7%, much deeper than the 0.3% contraction that had been predicted by markets.
The data and comments from policy makers add to a growing sense that the Bank will cut interest rates 0.25 basis points from their current 0.75% level, and the Pound has responded by going lower: the Pound-to-Euro exchange rate has fallen below the 1.17 level to trade at 1.1683 at the time of writing while the Pound-to-Dollar exchange rate has fallen below 1.30 to trade at 1.2996.
"GBP is underperforming moderately after MPC member Vlieghe said he would vote for a rate cut if there was no sign of a rebound in activity after the election," says Adam Cole, foreign exchange strategist with RBC Capital Markets.
Vlieghe told the Financial Times: "Personally, I think it’s been a close call, therefore it doesn’t take much data to swing it one way or the other – and the next few meetings are absolutely live. I really need to see an imminent and significant improvement in the UK data to justify waiting a little bit longer."
The comments follow on from those made by Governor Mark Carney last week in which he said there remained a strong case for lowering interest rates in light of ongoing economic weakness in the UK, and market expectations for an interest rate cut to be delivered by the Bank in early 2020 have increased.
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, just not soo soon.
Markets have sold the British Pound as they bring forward their expectations for an interest rate cut:
The Pound is down 0.60% against the Euro over the course of the past week and 1.30% down against the U.S. Dollar over the same time period with a 0.85% loss being recorded against Australia's Dollar.
"This has added further pressure at the start of the week on the Pound and seen markets increase the chances of a rate cut early this year," says Robin Wilkin, a cross-asset strategist with Lloyds Bank.
Above: Sterling's declines over the past week
"The GBP drop this morning unsurprising, have been saying for a while Q1 is a big question mark for the Pound, which will need to see a clear investment pickup to rally further," says Ranko Berich, Head of Market Analysis Monex Europe.
The comments by Carney and Vlieghe were last week echoed by another MPC member, Silvana Tenreyro, who said the economy could need monetary support within months.
"If uncertainty over the future trading arrangement or subdued global growth continue to weigh on demand, then my inclination is towards voting for a cut in Bank rate in the near term," Tenreyro said at an event hosted by the Resolution Foundation, a think tank.
"With two other members of the MPC, Saunders and Haskel, already voting for an immediate rate cut at the last two policy meetings, the market is likely to remain highly attuned to any further comments from the BoE’s nine-strong rate-setting committee," says Wilkin.
The concerted signalling of an imminent interest rate cut at the Bank comes despite the MPC yet to see any data that covers the economy's performance in the post election period.
There is a sizeable risk to their messaging that the economy picks up a head of steam following the strong election win for Boris Johnson, which allows the UK to exit the EU on January 31 and enter a transitional period where relations between the EU and UK remain unchanged.
The election win also means the threat of the disruptive far-left economic policies of Jeremy Corbyn's Labour Party being enacted are now jettisoned.
There has been preliminary evidence that the election corresponded with a sharp pick up in sentiment amongst British businesses:
1) Business confidence has surged amongst the UK's CFOs following the December General Election result, according to the latest Deloitte CFO Survey. Deloitte report "an unprecedented rise in business sentiment" in then fourth quarter of 2019, a survey that took place in the wake of the General Election.
2) Services PMI data showed a notable improvement in sentiment amongst those businesses that responded to the PMI survey following the election result.
3) Halifax house price data for December showed UK house prices grew at their fastest rate in 13 years in December, with the election result seen as being behind an uptick in activity.
Confirmation of an uptick in activity will however only come following the release of PMI data at the end of the month: this will provide the Bank with a clear sense of whether there is a potential post-election bounce underway. "Let's wait and see how the less lagged data prints before assuming BoE will cut. Political uncertainty can create some serious noise in UK data as it has done countless times. Next week's PMIs will be key," says Berich.
If the PMIs do reflect an improvement, the Bank will almost certainly opt to maintain a wait-and-see approach on interest rates, and this could offer the Pound a route higher.
However, Neil Wilson, Chief Market Analyst at Markets.com, says even a pickup in data won't be enough to prevent the Bank from cutting rates, as they sense a perfect window of opportunity to "juice the economy":
"Worth remembering that this data is backward looking and before the Tory victory, but this only adds to the sense that the BoE has a neat window of opportunity to cut this month."
Wilson says there is a sense the Bank doesn’t want to get behind the curve of market expectations, and is seeking to get a jump on markets whilst still teeing up the cut.
"It would be following the Fed’s playbook in cutting early in order to prevent a downturn. This is the key thing to remember – the Bank does not want to let a weaker economy fester," says Wilson, adding:
"Whilst there is no trade deal with the EU, the MPC has been largely released from the shackles of Brexit uncertainty following the Conservative victory last month. Political risk has hobbled the MPC but this has diminished greatly and now is the window – before a possible clash with the EU in the spring that would make policy changes more political in nature – to get a cut in the bag to juice the economy. .
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