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British Pound "to Recover" and Bank of England's Super Thursday will Help

- Bank of England's credibility on the line say Nomura

- Pound is a 'buy'

- But Mizuho reckon the Pound faces significant selling pressures as the next Bank move will be a cut

Nomura exchange rates

Strategists at global investment bank Nomura reckon the worst might have come to pass for Pound Sterling, and that it offers good value for traders at current levels.

Analysts at the investment bank's London office believe the British Pound is set to recover, and it will be helped thanks in no small part to the Bank of England which will be "unwilling to throw away its credibility".

The view is therefore on that rests with Bank of England policy, and comes days out from the Bank's May 10 policy meeting where the Bank will also release its latest updated economic forecasts.

Sterling has struggled over recent weeks as markets swung from holding a near-100% certainty that the Bank would raise rates 0.25%, to ascribing a sub-20% chance for such an event. The about-turn was prompted by a slew of underwhelming economic data releases and a warning from Bank of England Governor Carney that this underperforming data was not going unnoticed.

The Pound-to-Euro exchange rate had been as high as 1.16 in April as markets geared up for that rate hike, but it has since capitulated all the way back down to 1.1373. The Pound-to-Dollar exchange rate went as high as 1.4377 in April but has now retreated back to 1.3552.

The price action confirms to us that at present the movement of the Pound is highly correlated with Bank of England interest rate expectations, therefore the Pound's outlook now depends on what the Bank says regarding future policy.

"The market reaction over the past few weeks feels rather like this time last year when, just after we changed our BoE call to a very out-of-consensus hike at the August meeting, the short-term run of data disappointments led to caution from the BoE. GBP/USD sold off more than 3% as a result of that inflation report, but the BoE then hiked just three months later and GBP/USD is much higher as a result," says Jordan Rochester, an analyst with Nomura in London.

Nomura adopt a bullish stance going into the May 10 Bank meeting with an expectation that history might be about to repeat, noting that in September of last year the Bank was faced with a credibility problem of wanting to raise rates reasonably soon but in a market that failed to price for them.

So it introduced “coming months” into the statement to spur a steeper market curve i.e. interest rate expectations rose sharply, and this in turn boosted Sterling.

The Bank could once again be faced with the credibility problem this time around - having for so long banged out the message that a rate rises was more or less set for May, how can markets place trust in future Bank guidance if that rate rise is not delivered after a soft patch of data releases?

The moniker of "unreliable boyfriend" has haunted the Carney era, and the Bank will be conscious of this.

Rochester argues the Bank may again face a credibility problem if it were to err too much on the dovish side at this week’s policy event and Inflation Report, "so we expect it to deliver a balanced statement that will keep each MPC meeting live."

Nomura's view is certainly a bullish one and the British Pound will likely appreciate were it to prove correct.

Furthermore, we note that back in September 2017 when the Bank looked to condition markets for a November interest rate rise, the Pound was more-or-less around current levels against the Euro and US Dollar. At the time one of the key concern was that the currency was too week, and was therefore placing upward pressures on inflation. In short, a stronger Pound does much of the heavy lifting when it comes to controlling inflation, and with UK earnings finally getting back above inflation, the Bank will be wary of the good work being undone.

While targetting the currency is not an official objective we believe the Bank would be concerned by sharp decline in Sterling and would be happy to see some stability return to the market. Again, this argues for a pro-Sterling message being delivered this week.

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The Other Side of the Coin: The Next Move will be a Cut

Nomura's view is on the bullish side of the spectrum, on the other side of the spectrum are the bears who see further pain for the Pound ahead.

Those with foreign exchange purchases have been warned that Pound Sterling could "sell off hard" as the Bank of England cuts interest rates by 0.25% in coming months.

Neil Jones, a foreign exchange dealer with Mizuho Bank Ltd. in London, believes the next move at Threadneedle Street may be a cut, and not the increase in interest rates the market is expecting.

This is a remarkable call, particularly considering it comes just one week ahead of the Bank of England's May policy meeting, an event that until recently was widely expected to see the Bank raise interest rates by another 0.25%.

The call has significant implications for the outlook of the British Pound which has been closely correlated with Bank of England policy expectations during 2018, rising as expectations for interest rate rises increase, and falling when those expectations pare back.

Official data shows the UK economy to have barely grown in the first three months of 2018 which appears to have dented expectations for an interest rate rise with markets noting that the Bank risks smothering growth yet further if it pushes up the cost of borrowing.

Jones' note comes on the day that the services PMI for April was released by IHS Markit with data showing the all-important services sector failed to shake-off the weather-inspired slowdown of the previous month; the implication being that the economy is suffering a more broadbased slowdown.

For Jones, it is not only the softer data pulse the Bank will be eyeing, in fact it is the potential disruption posed by Brexit that presents the most significant consideration to Bank of England policy expectations, and by extension, Sterling.

"My sense is given the current state of play on Brexit negotiations, the MPC may well hold off until after March 2019 exit deadline ruling out any increase for 2018," says Jones. "With much uncertainty likely to weigh on consumer & business confidence, GBP will sell off hard."

The MPC did not hesitate to cut interest rates post the referendum, and Jones estimates "they will vote to keep the powder dry in case a repeat cut is required."

"The Pound will continue to sell off as the expectation shifts to no cut this year with a further sell off on a shift to a cut following a no deal hard-brexit after March 2019," says Jones.

Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here.