Pound Sterling a Buy says Strategist, Bank of England is Just Bluffing

- Sterling declines on expectations of interest rate cut

- But, Bank of England guidance is out of kilter says BMO Capital

- Poor data of 2019 is now old news

- MPC members guilty of "shock & denial" on Brexit

Bank of England's Carney

Above: File image of Bank of England Governor Mark Carney. Image © European Central Bank, reproduced under CC licensing.

- Spot rates: GBP/EUR: 1.1659, -0.03% | GBP/USD: 1.2989, +0.02%

- Indicative bank rates for transfers: GBP/EUR: 1.1350-1.1430 | GBP/USD: 1.2630-1.2730

- Indicative money transfer specialist rates: GBP/EUR 1.15-1.1550 | GBP/USD: 1.2750-1.2870 >>Get your quote now

Pound Sterling is a laggard on FX markets after the third senior Bank of England (BoE) policy maker within a week suggested that an interest rate cut could be imminent.

Gertjan Vlieghe - who sits on the BoE's Monetary Policy Committee that decides interest rates - 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.

However, we a leading foreign exchange strategist has said the Pound's current bout of weakness - largely driven by expectations for an interest rate cut at the BoE - could ultimately be short-lived, and as such Sterling is a buy on any weakness.

Stephen Gallo, European Head of FX Strategy at BMO Capital Markets says the Brexit process has in fact "unearthed an important bias at the BoE", who are potentially suffering a case of "shock & denial" on the Brexit process and are therefore gunning for an interest rate cut, despite a potential post-election pick up in UK economic activity.

As such, Gallo says dips in Sterling are a buy as the currency will ultimately recover.

The British Pound fell below the psychologically significant 1.17 level against the Euro and 1.30 level against the Dollar at the start of the new week amidst fresh signs the Bank of England was poised to cut interest rates in early 2020.

The message from the Bank is clear: don't be surprised if interest rates are cut this January. First Governor Mark Carney, then Silvana Tenreyro and now over the weekend Gertjan Vlieghe, said the recent slowdown in UK economic activity could warrant an interest rate cut in order to defend growth.

Should these three MPC members vote for a cut this month, they would join Michael Saunders and Jonathan Haskel who both voted to cut rates in November.

The implied odds of an interest rate rise have risen above 52% for a rate cut to be delivered at month-end, up from just 5% last week, owing to the intervention of the three MPC members.

"In direct response, the Pound has come under pressure, as you would expect when relative interest rate expectations change, and it has surrendered its $1.30 level," says Nigel Green, chief executive and founder of deVere Group.

The BoE is now the primary driver of the British Pound, after politics was relegated to the back seat following the decisive win at the December polls of Boris Johnson's Conservative and means those watching Sterling will keep an eye out for economic data releases and any further communications from Threadneedle Street over coming weeks.

The general rule of thumb in financial circles is that when a central bank lowers interest rates, the currency it issues declines in value. Green says increasing hints that the Bank of England will cut interest rates is likely to prompt investors into overseas financial assets; "we can expect more Sterling turbulence, and as a result, we are likely to see investors increasing their exposure to overseas financial assets, including global equity funds."


Why the Pound is a Buy

But, Gallo says the negativity in Sterling built around expectations for a Bank of England cut could be misplaced, and the currency therefore looks like an attractive prospect for those willing to speculate on a recovery.

Gallo says he can think of at least three reasons why investors should buy the dip in the Pound:

One: "weak economic data from the UK are 'old news' and we are in a 'new world'".

Two: "some commentators still appear to be in the "shock & denial" or "anger" phases of the Brexit grieving process and therefore wedded to a certain bias."

Three: "looser BoE policy in the short-run should make the rebound in the GBP from any forthcoming 'fiscal impulse' even larger as the stimulative effects collide with one another."

Declines in Sterling, and an apparent willingness to cut interest rates at the Bank of England, coincide with the latest set of GDP data from the ONS which showed the UK economy shrank 0.3% in November. However, the same report also showed the economy grew 0.1% in the three months to November, which was better than markets had been expecting. Upward revisions were made to both the September and October readings.

"Markets seem to have overlooked the positive revisions to GDP growth in prior months," says Samuel Tombs, UK Economist with Pantheon Macroeconomics.

The data released on Monday covered the November period, and is therefore outdated, particularly given the sizeable political shift witnessed in the UK at year-end. The risk is the Bank's policy setters have overemphasised the negative data that rolled in ahead of the election outcome.


Signs of Life in the Economy Make BoE Intervention "Odd"

There has been preliminary evidence that the election corresponded with a sharp pick up in sentiment amongst British businesses, but strategist Viraj Patel at Arkera says there were signs that the outlook was improving even before the election. The "timing of dovish BoE communications is strange," says Patel. "Leading investment indicators (BoE Agents Scores, PMI Business Activity) & consensus UK 2020 GDP growth have all been turning higher... even before the UK election. Risk UK businesses now delay investment until the BoE cuts. Strange!"

That the Bank appears out of step with developments in the economy in turn suggests the latest slip in the Pound is also out of kilter.

"Markets once again mispricing UK GDP outlook, Brexit risks & BoE policy," says Patel. "Creates good opportunity to initiate fresh long GBP,USD positions. Would be unusual for BoE to act before March Budget (given government's planned fiscal easing tone."

Those looking for evidence that the economy could be about to turn higher should consider the following: 

One: 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.

Two: Services PMI data for December showed a notable improvement in sentiment amongst those businesses that responded to the PMI survey following the election result.

Three: 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.

"Given the exceptionally clear election outcome and the associated decrease in political risk, I consider the current debate regarding an interest rate cut to be rather inappropriate. I don't expect a rate cut in January," says Marc-André Fongern, Head of FX Research at MAF Global Forex.

"Once again, the UK Pound is suffering from a disproportionately pessimistic risk assessment, similar to last year. The recently bulldozed currency continues to be attractive in my opinion," adds Fongern.

Key to the outlook will be the release of the trio of PMIs covering January, due out on January 24. This will be the first real post-election survey that the Bank of England will be able to digest; it should give a hint as to whether they should sit on their hands and let the economy evolve before making a call on interest rates.

A better-than-expected set of data out on January 24, 27 and 28 could therefore be the next big triggers for the Pound which is once again apparently focused on economic fundamentals.

But whether the Bank takes note of the data is another matter; they could yet choose to ignore potential improvements in data, and spy an opportune window to cut interest rates.

The window falls before trade talks before the EU-UK begin in earnest as the Bank won't want to be deemed to be taking politically-motivated decisions over the course of the year. Therefore, an insurance cut ahead of any potential trade talk anxiety being suffered by the economy could be considered prudent by the MPC.

BannerTime to move your money? The Global Reach Best Exchange Rate Guarantee offers you competitive rates and maximises your currency transfer. They offer great rates, tailored transfers, and market insight to help you choose the best times for you to trade. Speaking to a currency specialist helps you to capitalise on positive market shifts and make the most of your money. Find out more here.

* Advertisement

GBP/EUR download banner