Pound Sterling vs. Euro and Dollar 5 Day Forecast: Beware Bank of England Surprise

- GBP/EUR technicals
- GBP/USD technicals
- Bank of England provides fundamental focus
- Vaccines, markets could be key drivers

• Market rates at publication: GBP/EUR: 1.1309 | GBP/USD: 1.3680
• Bank transfer rates: 1.1090 | 1.3400
• Specialist transfer rates: 1.1230 | 1.3580
• More about bank-beating exchange rates, here

The British Pound is liable "to get a shock" this week if the Bank of England cuts interest rates, says an analyst we follow, signalling one of the potential near-term pitfalls to 2021's trend of appreciation in Sterling.

A consensus expectation amongst analysts is that the Pound will this week trade on a combination of broader market sentiment, positivity surrounding the UK's vaccination programme and the decision delivered by the Bank of England on Thursday.

"Sterling could suffer if the Bank of England unexpectedly cuts interest rates by 10 basis points to zero next week," says Robert Howard, a Reuters market analyst.

The Pound started the new week on a firm footing amidst confidence among economists that the Bank keeps interest rates at 0.10%, while opting to leave quantitative easing levels unchanged.

54 of 57 economists polled by Reuters earlier this month forecast that the BoE would leave the Bank Rate at 0.1% on Feb. 04.

"We expect no policy changes from the BoE next week, but look for it to conclude the negative rates review by cutting lower bound to perhaps -50bp, making rate cuts the marginal tool again. One reason the negative rates discussion stays live is likely very low neutral rates in the UK. On that front we cut our potential growth estimate to 0.4% per year," says Robert Wood, UK Economist at Bank of America.

Above: The Pound is 2021'a best performing major currency.

But a surprise change to these settings could cause a sharp decline in the Pound, after all what the Bank does matters for Sterling.

"This month's sterling gains have been influenced by a decline in the perceived likelihood of the BoE's reducing rates below zero this year. A cut to zero would revive that probability," says Howard.

Even if the Bank does not opt to change settings, its messaging on the future of interest rates could be equally important. The rule of thumb here being that a signal for a rate cut in coming months = negative for the Pound.

"The BoE is due to publish on Feb. 4 feedback from banks about what negative interest rates would mean for their operations, a first stage of the BoE's consideration of the pros and cons of taking borrowing costs below zero," points out Howard.

If markets bring forward expectations for negative interest rates as a result, the Pound could decline.

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Market Volatility

How the Pound trades over coming days could well ultimately be determined by broader market forces.

"The GBP has become more correlated again with global equity market performance this month which could reflect the fading impact of Brexit risk," says Derek Halpenny, Head of Research at MUFG.

The British Pound eased back against key rivals last Wednesday and then again on Friday amidst tumultuous sessions for stock market that saw all of 2021's gains in some indices erased in a matter of hours.

The Pound's sensitivity against the Dollar, Yen and Franc served as a reminder that against these currencies investor risk sentiment matters. When markets are ascendent the Pound tends to rise, but it falls when markets reverse.

Anxieties created by swarms of retail traders targeting heavily shorted stocks to flush out hedge fund 'shorts' has destabilised markets sentiment of late and served up as a reminder that markets cannot be expected to rise indefinitely.

The GameStop share price surge is the prime example and focus of a new phenomenon in equity markets, whereby the stock rocketed and in doing so delivered a savage blow to institutional investors and hedge funds that were betting against the stock.

"While the activity of a small distressed gaming retailer in the US should not have a significant impact on the rest of the world we believe the situation is causing hedge funds and their funders to go ‘risk-off’ and deleverage their investments causing funds to liquidate positions across the board," says analyst John Meyer at brokerage SP Angel.

This suspicion was confirmed by Goldman Sachs data out over the weekend that showed hedge funds were diverting significant sums of money out of equity markets at the fastest pace since 2014.

When these corrective flows settle, the market could find itself better supported.

Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.

The Vaccine Backstop

A slew of good news regarding vaccines over the past week is likely to ensure the UK maintains a vaccination rate that outpaces those in other G10 countries, potentially allowing for the UK economy to be unlocked earlier than elsewhere.

This could bestow an element of outperformance on Sterling over coming days and weeks.

"We expect the vaccination advantage of the UK to keep driving EUR/GBP lower in the rest of 2021," says Francesco Pesole, FX Strategist with ING.

Pharmaceutical company Janssen - owned by Johnson & Johnson - on Friday announced their single-shot candidate had shown high efficacy, and that submissions for authorisation would now begin.

The UK has ordered 30 million doses of the jab, which has been made available on a non-profit basis, and an adviser to the UK's Vaccine Taskforce says it could be approved and rolled out in February.

It appears that supply is the only major limiting factor to the UK's vaccination programme, and given an increasingly hostile EU, the news will shore up confidence in the UK's programme.

GBP/USD: Technicals

"Strength has been capped as feared at near-term trend resistance from the beginning of the year at 1.3759/62, maintaining the possibility a small bear "wedge" may be forming," says David Sneddon, technical analyst with Credit Suisse.

Sneddon eyes short-term support at 1.3610/05 which needs to hold to allay fears that a more bearish setup is forming, with resistance seen at 1.3721/31 initially, above which can see a retest of 1.3759/62.

GBP/EUR: Technicals

Sneddon maintains a bullish view on the GBP/EUR exchange rate, noting it to be supported at its 13-day exponential average 1.1246 and key near-term price support is at 1.1210.

He says this keeps the immediate risk for the pair pointed higher.

Medium-term resistance is at 1.1272/1.1285, Sneddon continues to "look for a clear and sustained move" above here to finally confirm a long-held view a major turn higher for the exchange rate.

A target of 1.1532 is identified.