Bank of England: Predictions for Pound Sterling vs. Euro and Dollar as Negative Interest Rates Verdict is Delivered

- Soc Gen looks for a rate cut
- GBP/USD to 1.40 if Bank says -ve rates not feasible: MUFG
- GBP/EUR down to 1.1286 if vote on -ve rates is split: TD Securities

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The Bank of England's February policy decision forms the key risk for the British Pound on Thursday as foreign exchange markets eagerly await a verdict on whether an interest rate cut to 0% or below is likely either today, or at some point in coming weeks and months.

Such a rate cut has never been attempted in the UK before and the Bank's decision will therefore have significant implications for the UK financial system.

For Sterling exchange rates, a cut to zero is widely considered by foreign exchange analysts to be a negative outcome and the currency could therefore come under sustained pressure if Governor Andrew Bailey and the Monetary Policy Committee (MPC) opt to cut rates.

The Pound has rallied through the course of 2021 on a view that the Bank is moving away from negative interest rates, therefore should the Bank confirm negative rates are unlikely the Pound could extend its uptrend.

Above: GBP is the top performing major currency of the past month.

"For FX markets, the debate around negative rates is likely to prove the most significant for GBP given the pound’s historic sensitivity to rate differentials. UK yield differentials have been steadily widening in favour of a higher GBP. We identify the 4th February meeting as pivotal to sterling moves in a month in which it faces traditional headwinds," says Kamal Sharma, a foreign exchange strategist at Bank of America.

The consensus view is that the Bank is willing to keep interest rates unchanged and look through current difficulties facing the economy, choosing instead to focus on a spring rebound in economic activity.

An interest rate cut would therefore likely wrong-foot the market and undermine the rally in the British Pound, potentially triggering a sharp reversal in value, as noted in our week-ahead forecast article.

"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.

Thursday's event will also see the Bank report back on the findings of a review into whether negative interest rates would be feasible in the UK.

The Bank's Prudential Regulation Authority initiated a review into the matter last October, and their findings will likely determine whether a cut to 0% or below is possible without negatively impacting the country's financial services sector.

"The review of negative interest rate policy is likely to have been finished. We think the committee will say that such a policy is feasible and worth doing because it would provide a meaningful stimulus," says Brian Hilliard, an economist with Société Générale.

In a speech delivered in January, MPC member Silvana Tenreyro said she believed negative interest rates would be a positive development that can further aid the under-pressure UK economy.

However, other members of the MPC, including Governor Andrew Bailey, said in January it was too soon to consider cutting interest rates, even if it were an option worth considering over coming months.

Ahead of the event, the GBP/EUR rate is quoted at 1.1356 on the spot market, with banks quoting around 1.1130 for money transfers and independent providers quoting around 1.1270. The GBP/USD exchange rate is quoting around 1.3648 on the spot market with banks quoting around 1.3366 for money transfers and independent providers quoting around 1.3550.

The Positive Scenarios for the Pound

Foreign exchange analysts at investment bank TD Securities say they assign a 70% chance the Bank's Monetary Policy Committee (MOC) votes 9-0 to keep rates and Quantitative Easing unchanged.

2021 economic growth and inflation forecasts are meanwhile expected under this scenario to be lowered, but the Bank is expected to emphasise its expectation for a strong rebound in economic growth later this year thanks to the vaccine roll-out.

TD Securities assumes the MPC adds negative rates to its toolbox and says lower bound for Bank Rate is now below 0.00%, but makes clear that rate cut is not being considered anytime soon.

Under such a scenario they forecast the Pound-to-Dollar exchange rate to rise to 1.3720 and the Pound-to-Euro exchange rate to rise to 1.1416.

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Derek Halpenny, Head of Research at MUFG says the Bank of England meeting is set to be important in determining if the British Pound continues to outperform in the near-term.

"Market participants have scaled back rate cut expectations ahead of the meeting which has helped to lift the GBP," says Halpenny.

According to the analyst, the argument against cutting rates and boosting quantitative easing has been dampened by:

i) December's EU-UK trade deal
ii) resilience of UK economy at the end of last year
iii) relatively fast roll out of vaccines in the UK

"The most bullish potential outcome for the GBP would be if the BoE leaves the key policy rate unchanged, and the consultation with lenders further dampens speculation over negative rates in the near-term," says Halpenny.

Under such a scenario MUFG envisages further gains for the Pound with the GBP/USD exchange rate moving closer to 1.4000 and EUR/GBP towards the mid-0.8000's.

TD Securities say an all-out bullish scenario would see the Bank report that negative interest rates are not feasible to be part of the BoE's toolkit in the near future.

If more stimulus is needed, it will come only via quantitative easing and other lending programmes like TFSME.

The Pound-to-Euro rate is forecast at 1.15 and the Pound-to-Dollar at 1.3820 under such a scenario which is assigned a 10% weighting.

The Negative Scenario for the Pound

Regarding the possibility of a negative surprise to Sterling, TD Securities say there is a 20% chance, in their view, that the MPC votes 2-3 for negative rates.

Those members that vote for a rate cut would do so having observed the downgrades to the near-term economic outlook.

Under such a scenario the Pound-to-Dollar exchange rate is forecast to fall back to 1.3540 and the Pound-to-Euro exchange rate back to 1.1286.

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Analysts at MUFG are also cautious of a negative surprise warning the tougher third lockdown is expected to deliver a larger negative hit to growth at the start of this year.

"It could still encourage the BoE to provide more stimulus to act as insurance against downside risks even if they are more confident of a stronger recovery beyond," says Halpenny.

"There are clear downside risks as well for the GBP. A rate cut to 0.00% or even into negative territory can’t be completely ruled out although appears less likely now," he adds.

Analysts at Société Générale expect a decidedly bearish outcome for Sterling exchange rates as they anticipate the MPC to cut interest rates and announce a boost to the existing quantitative easing programme by £150BN

Société Générale are of the opinion the Bank will want to maintain a proactive approach to policy and will deliver a small cut. They cite the argument of MPC member Michael Saunders that any further rate cuts should be done in smaller increments than the standard 25bp, to maintain a realistic expectation in the markets that further cuts would be possible.

"On this basis, we expect the easing package to include a cut in Bank Rate to precisely zero, accompanied by an expansion of the Term Funding Scheme (possibly following the tiering approach of the ECB TLTRO) to mitigate the impact of the cut on banking profitability," says Soc Gen's Hilliard.

Give how removed from the consensus view this stance is, the Pound would likely endure a sharp and potentially enduring decline in value.