Pound Sterling Firms on Lingering Doubts over Bank of England Rate Cut

- Pound recovers lost ground
- Bank of England is now main driver of Sterling
- Markets not convinced a Jan. rate cut is set in stone

Pound yet to buy into Bank of England rate cut story

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- Spot rates: GBP/EUR: 1.1743, -0.07% this week | GBP/USD: 1.3076, +0.08% this week

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The British Pound has traded with a firmer tone against the Euro, Dollar and other major currencies in the second half of the week after markets showed they are unwilling to bet a Bank of England interest rate cut at the end of the month is a certainty.

Sterling gone sharply lower at the start of the week after market pricing for a rate cut rose sharply after a number of Bank of England policy makers came out and said the slowing economy could use a rate cut. The rule of thumb is that currencies lose value when their issuing central bank enters into an interest rate cutting cycle.

However, the Pound's resilience is clearly on display and markets are yet to fully buy into the notion that now is the time to cut interest rates in the UK and are instead opting to wait for data out next week that could yet show the economy has experienced a post-election bounce:

The Pound-to-Euro exchange rate has climbed back above 1.17 to be quoted at 1.1743 at the time of writing, the pair had been as low as 1.1630 earlier in the week. "GBP was the top performer on Thursday... as markets shrugged off a potential BoE rate cut and weak UK data," says a currency briefing note from Hong Leong Bank Berhad.

The Pound-to-Dollar exchange rate is quoted at 1.3075, having been as low as 1.2954 earlier in the week.

"GBP rose to a 1-week high of 1.3083 before ending the day on a firm note at 1.3076 (+0.28%). Upward momentum remains positive and from here, GBP could continue to advance towards 1.3105," says Quek Ser Leang, an analyst with UOB in Singapore.

A number of currency analysts we follow believe that a rate cut risks making the Bank seem out of step with the economic reality on the ground, as numerous surveys suggest a pickup in economic activity following the December General Election is underway.

"Our expectation for an on-hold policy decision should help stem further GBP weakness," says Ned Rumpeltin, European Head of FX Strategy at TD Securities. "The reason for holding off on easing though is the expectation that growth will stage a fairly substantial recovery now that political uncertainty has receded; this seems to be the dividing line among MPC members."

Sterling in recovery mode

The downside surprise to November GDP - which read at -0.3% and was released earlier this week - "seems to be related at least in part to the 31 October Brexit deadline," says Rumpeltin.

The ONS also made upward revisions to the September and October GDP data that actually left the level of GDP roughly in line with what economists had expected it to be at this point in time, despite the negative shock to November growth.

"So overall growth isn't all that different from what was expected and buys the MPC more time to sit back and watch how the data evolves, despite the optics around the unexpected November contraction," says Rumpletin.

However, the key deciding factor for the Bank of England - that could mean the difference between a cut and a hold - will be the release of flash PMI data on November 24.

"The flash manufacturing and services PMIs for January will likely be key important inputs into the BoE's rate decision, as they've had a strong influence on policymaking in the past, given their timeliness," says Rumpletin.

It looks like markets are aware that the data could swing the outlook for Bank of England policy, and in turn Sterling. As such, the currency has recovered some of the ground it lost earlier this week.

"Our expectation that the BoE will keep rates on hold this month should help stem further losses. With roughly a 50% chance of a rate cut priced in to the curve, the unchanged result we look for should provide near-term support," says Rumpletin.

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