- BoE is Key domestic event in Sterling's calendar
- "Sterling may spike higher tomorrow morning" - Western Union
- "Hawkish surprise could help GBP close its value gap" - TD Securities
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- GBP/EUR spot: 1.1068 | GBP/USD spot: 1.3133
- GBP/EUR bank rates: 1.0860 | GBP/USD bank rates: 1.2865
- GBP/EUR specialist rates: 1.0970 | GBP/USD specialist rates: 1.3015
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The Bank of England will deliver their August Monetary Policy Statement at 07:00 AM on Thursday morning, forming the highlight of the week for the British Pound.
No change to quantitative easing or interest rates are expected by the markets, particularly given quantitative easing was boosted by a further £100BN in June, taking the total value of the programme that sees the Bank buy government and corporate bonds to £745BN.
With no major decisions due for announcement the focus for currency markets will be on what the Bank signals with regards to future policy decisions: do they strike a pessimistic tone on the economy and warn more action might be needed, or do they hold tight and signal confidence in the recovery.
"More important will be signals for policy going forward, based on the balance of risks for the economy. For the MPC, risks remain skewed to the downside, so the key message that the BoE is likely to repeat is that it will do everything it can to support the recovery," says Robin Wilkin, Global Cross Asset Strategist at Lloyds Bank.
A pessimistic signal would likely lend itself to a weaker Pound, while a more confident assessment that would suggest no further quantitative easing expansions are likely over coming months could contribute to Sterling upside.
"Investors are poised for an update on the possibility of negative interest rate policy and whether hopes of a 'V-shaped' recovery are still on track. Should the BOE deliver a more optimistic message, then Sterling may spike higher tomorrow morning. GBP/USD could challenge 5-month highs near $1.32, whist GBP/EUR could extend towards €1.12," says George Vessey, Currency Strategist at Western Union.
Foreign exchange strategists at TD Securities are adopting a base-case scenario - given a 55% probability - that the Bank moves to "more realistic macro forecasts, with slower recovery from H2 2020 onwards and GDP back to end-2019 level in 2022/23."
This would entail predicting an unemployment rate of around 8% by the end of 2020, in line with consensus estimates amongst the economist community. 2-3 year inflation forecasts maintain prices will stay below the 2% target and the Bank states it is "stands ready" to do more.
Under this base-case scenario the Pound-to-Dollar exchange rate is seen going to 1.3110 (current level is at 1.3142) while the Pound-to-Euro exchange rate is seen going to 1.1086 (current level is at 1.1070).
However, a 'hawkish' scenario - given a 35% probability by TD Securities - sees the Bank release further illustrative scenarios for the economy as opposed to releasing formal forecasts which is suggestive policy makers are still too uncertain as to the shape of the recovery.
Such a scenario would account for the v-shaped recovery that the Bank's Chief Economist Andy Haldane has hinted at in past speeches. With a view that the economy might recover in a robust and timely fashion, TD Securities says there would be little room for an argument to be made for boosting quantitative easing before the end of 2020.
This would on balance be supportive of Sterling, and the Pound-Dollar rate could go to 1.3170 under such a scenario with the Pound-Euro rate going to 1.1173.
"Our base case suggests a limited reaction as USD direction dominates. Dovish shifts represent the MPC marking itself to market. A hawkish surprise could help GBP close its value gap, but sterling still faces headwinds from a sluggish recovery and ongoing Brexit concerns," says Jacqui Douglas, Chief European Macro Strategist at TD Securities in London.
"A dovish BoE could send the pound lower. GBP/USD could fall under the $1.30 handle, which may then become a new resistance point, whilst GBP/EUR could slip under the €1.10 threshold that has supported well for the past week or so," says Vessey.
Another key topic to watch out for will be the matter of negative interest rates. The Bank has indicated it is reviewing the 'lower bound', which is the lowest level it believes interest rates can be cut to before the cease having any positive effects on the economy.
The current lower bound is 0.1%, where the Bank Rate currently rests.
Should the Bank suggest the rate can go lower the economy then enters the realm of negative Bank Rates, which would be an unprecedented step for policy makers to take and one that could have significant implications for the economy and financial system.
The general line of thinking is that such an outcome would be particularly harmful for Sterling exchange rates considering the UK would be the first economy to be subject to negative interest rates at the same time as having both a fiscal and current account deficit.
In short, Sterling requires inflows of foreign exchange from the global investment community to sustain value and if rates are cut to negative the disincentive to foreign investors could be so large that a sizeable decline in the value of the currency must take place to compensate investors and attract inflows once more.
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