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Carney & Co Talk Interest Rate Cuts at Treasury Select Committee Hearing

The British pound has fallen to fresh lows as markets realise the Bank of England has turned more 'dovish' and could potentially cut interest rates in the future.

Carney, Weale and Shafik to appear before Parliament

The GBP is under pressure in mid-week trade as markets digest the news that the Bank of England is open to fresh stimulus if economic conditions deteriorate over coming months.

Key members of the Bank of England's monetary policy testified before Parliament’s Treasury Select Committee on Tuesday, included were Governor Mark Carney, Deputy Governor Minouche Shafik as well as MPC members Gertjan Vlieghe and Martin Weale.

Markets continue to place little chance of an interest rate rise until 2019 ensuring the pound finds little support from interest rate markets. Higher interest rates attract capital from from across the world as investors look for higher yields on their investments.

Hence, the promise of higher rates attracts more capital inflows and pushes the value of sterling up as a result. Lower rates has the opposite effect.

And, suggestions that interest rate cuts are now not completely off the table really caught our attention.

When asked how he could be so confident that the next move would be up rather than down, Carney said:

"I think we should be clear about what that statement says.

"It says: over the forecast horizon interest rates are more likely than not to increase … but we are not on a preset course and of course if risks were to materialise and the global situation were to intensify to the downside, that would have implications for the path of policy."

The Committee appears to be more cautious i.e. shifting into dovish mode.

While domestic economic growth appeared resilient, the MPC were closely monitoring whether market uncertainty emanating from the EU referendum would impact firms’ investment intentions and household’s spending plans, which they felt was very possible.

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Barclays' Andrzej Szczepaniak says the comments add to the sense that this is a more cautious central bank:

"It was remarked that should the UK economy deteriorate, or should the global economy deteriorate further than it already has relative to the forecast in the February 2016 Inflation Report, the Committee had the necessary tools to provide stimulus as required."

Stimulus included more quantitative easing, changing the policy horizon (eg, amending the time frame for inflation returning to target), as well as cutting the Bank Rate.

"Indeed, there was significant discussion regarding how the Committee now felt more comfortable that the Bank Rate could go below 0.5%, but nonetheless stay strictly positive," says Szczepaniak.

Vlieghe, who is still fresh on the committee but has proven himself to be firmly in the dove coop, provided the clearest indication of what may induce him to vote for a rate cut.

He remarked that he has "little tolerance for further downside surprises", and should they continue, "we will get relatively quickly to a point where I find it appropriate to respond to it".

Pound Under Pressure as GBP/USD is a 'Sell on Rallies' Target

The pound has fallen to fresh lows on the back of the news. The pound to euro exchange rate is at 1.2718, having started Tuesday above the key support at 1.28. Bank transfer rates are seen as low as 1.2360, independent payments are being offered at rates in the mid 1.25s.

The pound to dollar exchange rate is at its lowest levels since 2009 when the full extent of quantitative easing and interest rate cuts at the Bank of England were being felt. Banks are offering rates at around 1.36-1.37 while independent specialists are quoting payments from around 1.38.

"The market is nowhere near record shorts and our CitiFX Technicals team now looks for an initial move to 1.3954, a break of which leaves support at 1.3657-82 and then 1.3503 which is the January 2009 low as the unit remains a firm ‘sell on rallies’ while the 1.4250/70 now looks to be the sell zone," says a strategy note from Citi, the world's largest foreign exchange dealer.

Highlights of the Testimony

The GBP has not found the support bulls would have been hoping for. Highlights include:

  • The MPC could cut interest rates rates, add to QE and shorten the policy horizon to return inflation to target level
  • Monetary policy is seen as stimulative, domestic demand positive
  • UK current account deficit still very large, in part a side effect of weaker Eurozone economic performance may need to run trade surplus for which weaker exchange rate is needed
  • Still no concerns over current or weaker pound keeps GBP on the back foot but off its lows.
  • Number of structural adjustments needed for Chinese economy, China/PBOC aware and have resources to make it happen

Ignore Any Whiff-Whaff, GBP Downside to Prevail

The above title is the catchy subject line to ING’s morning research offering to clients.

It speaks volumes of how markets perceive sterling at this juncture in time and hints at why speculative markets will be determined to eke out more gains on selling the GBP/USD.

“We suspect that the overall cautious MPC tone will stem any hopes of a GBP squeeze higher and instead see the fragile risk environment adding to currency’s woes. Look for cable to test the 1.4050/70 area, with a break below paving the way for a more broader move towards the psychological 1.40 level,” says Viraj Patel at ING.

Pound to Dollar at Formidable Support

Sterling remained under selling pressure at the start of the week, breaking down through the recent 1.4080 lows, a move that suggests further downside potential is possible

However, history suggests a substantial move lower is unlikely at this stage.

“We are out of line with rate spreads now, as the market approaches key psychological support in the 1.40 region. It is worth bearing in mind that 1.40-1.35, the latter being the 2009 lows, has been support since the mid-1980’s,” says Robin Wilin at Lloyds Bank.

So this will be a formidable region the market needs to break down if we are to see those levels many FX strategists are talking about.

HSBC warn on Parity in EUR/GBP, But See No Stimulus to Exports

A new note on the uncertainty of sterling's outlook in a post-Brexit landscape has been issued by HSBC.

In the note we are warned that the GBP/USD could fall 15-20% against  the dollar while hitting parity against the euro.

Interestingly HSBC make little of the stimulatory effect on the UK export sector such a decline would bring.

HSBC simply acknowledge "UK exports should become more competitive."

The short part-sentence is quickly countered with the argument that, "sterling would have been driven down by uncertainty surrounding future trade arrangements with the UK’s largest trading partner, which could deter potential buyers of UK exports within the EU, despite lower prices (in EUR terms)."

The argument is sketchy at best - at no point has an argument been made that all trade agreements with the UK and the rest of Europe would be torn apart. Sure, there would need to be some negotiations in the future but the status quo would surely be left in place while negotiations proceeded.

And it is in neither the UK's nor Europe's interest to inhibit trade.

Furthermore, EU companies are rational, profit-driven, entities that will pick up cheap goods no matter where they are produce. Suggesting they would shun sterling-induced bargains on their doorstep is hard to imagine.