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The Pound-Dollar Rate Can Fall Further if BoE Rate Cut Probability Rises

- GBP/USD decline not over yet says CBA strategist. 

- MPC majority could favour rate cut as soon as Jan.

- Vlieghe, Tenreyro, Carney, Saunders, Haskell eye cut.

- GBP not priced for move quite so soon so is vulnerable.

- CBA tips GBP/USD fall as ING also eyes more weakness.

- But Capital Economics and BMO look for GBP recovery.

© Bank of England 

- GBP/USD Spot rate: 1.2968, down 0.13% today

- Indicative bank rates for transfers: 1.2513-1.2603

- Transfer specialist indicative rates: 1.2772-1.2850

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The Pound is already plumbing the bottom of the major currency barrel for 2020 but it has further to fall against the Dollar in the weeks ahead, according to multiple analysts, who all say the British currency is unprepare for an interest rate cut that could come as soon as the end of this month. 

Sterling is among the worst performing major currencies of the last week, behind only the safe-haven Japanese Yen that's been sold by the bucket load as investor risk appetites recover ahead of Wednesday's anticipated signing of the U.S.-China trade deal. It's also bottom of the major currency barrel for 2020, with the Pound-to-Dollar rate slipping more than 1% in recent days as Bank of England (BoE) policymakers began preparing markets for a rate cut. 

"The likelihood is the UK economy records a contraction in Q4," says Richard Grace, head of FX strategy at Commonwealth Bank of Australia. "Given the sluggishness in the economy and the transitional headwinds of the Brexit process, we believe the UK economy requires both monetary and fiscal stimulus. We believe the Bank of England will cut rates by 25bp on 30 January." 

Above: Pound Sterling performance relative to major rivals in 2020. Source: Pound Sterling Live.

The Pound has suffered as investors increasingly price-in a possibly imminent interest rate cut from the BoE, with bets against Sterling increasing on Monday after Monetary Policy Committee member Gertjan Vlieghe said that he will vote for an interest rate cut this month if the UK economic outlook does not improve, echoing comments made by the Governor and colleagues last week. 

"If the MPC can't reach a majority the current pricing of 61.5% for a 26 March interest rate cut is likely to increase on news of a divided MPC, encouraging a GBP/USD depreciation," Grace writes in a note to CBA clients. "We believe GBP will depreciate to the 200-day moving-average of 1.2691. GBP/USD is particularly sensitive to UK-US interest rate differentials." 

Vlieghe told the FT that without a “imminent and significant improvement” in UK economic data he'll vote for a rate cut this month. The interview aired just hours before the Office for National Statistics (ONS) said the economy shrank a notable 0.3% in November, leaving GDP down -0.2% for the final quarter with just one month left to go for 2019. The economy grew 0.7% in the 11 months to the end of November but markets are looking for 1.3% from the year overall. 

Above: Pound-to-Dollar rate shown at hourly intervals.

Already two members of the nine-strong MPC voted to cut rates in December so if the Governor and his two colleagues were also to vote that way on January 30 then a reduction of borrowing costs would be all but guaranteed. And once the first cut is in there'd be plenty of scope for markets to price further easing into the bond market for a later date, which would be certain to weigh on Sterling.

"The market is currently pricing above 50% probability of a cut in the January meeting. With GBP/USD speculative positioning turning sharply over recent months - from net shorts (close to 40% of open interest) in mid-September 2019 to net longs (8% of open interest) currently - the downside risk to GBP is building. Bar a possible rate cut, the uncertainty about the EU-UK trade deal (to be reach this year) should also limit GBP upside throughout 1H20," says Chris Turner, head of FX strategy at ING.

Sterling is still unprepared for a cut any time soon but it was doubly so when outgoing Governor Mark Carney said last week cuts will follow any fresh signs of economic weakness. Carney says the BoE can provide 250 basis points of easing in response to a downturn despite Bank Rate being at only 0.75%, while colleague Silvana Tenreyro also indicated she's contemplating voting for a cut.

Above: Pound-to-Dollar rate at daily intervals with GB-U.S. yield differential. Gap between two lines represents 'risk premium'.

Monetary Policy Committee members are contemplating whether to cut rates in order to bolster the growth rebound that they still anticipate for the UK this year, according to Carney, who also said last week there's plenty of scope for more quantitative easing up ahead if it becomes necessary. The economy had a tough few quarters in 2019 and saw no let-up into year-end as all sectors struggled ahead of October's Brexit deadline and U.S.-China trade deal. 

"Given our view that the Bank of England (BoE)’s next move will be to tighten policy, we suspect that sterling and Gilt yields will bounce back before long," says Hubert de Barochez at Capital Economics. "We suspect that rates will be left on hold this month, and that the balance within the MPC will then shift back towards a rate hike as the economy rebounds. As it happens, there is already some evidence of an improvement in the economic data since the general election. With all that in mind, we forecast that sterling will rise back to $1.35 before the end of 2020."

Pricing in the overnight-index-swap market implied on Tuesday a January 30 Bank Rate of 0.65%, which is close to the halfway point between the current 0.75% level and the 0.50% that would prevail following a typical 25 basis point rate cut. That means Sterling is thoroughly unprepared for a possible rate cut this month while the 0.58% implied rate for April suggests the Pound is not even prepared for a cut by the beginning of the second quarter. 

Above: Pound-Dollar rate at weekly intervals with GB-U.S. yield differential. Gap between two lines represents 'risk premium'.

Consensus has envisaged from moment one GDP growth of 1.3% for the year, down from 1.4% in 2018, although even that now looks ambitious because the economy needs a 0.4% final quarter expansion to achieve it.

Some might call suggestions of a 0.4% increase pie in the sky now the economy is running at -0.2% with only one month left to go in the quarter, although such a move wouldn't be without precedent. January 2019 saw a 0.5% monthly increase in GDP, which was aided by a 'base effect' given the economy had previously contracted 0.4% in December 2018.

"With spot trading at around 1.30, we think GBPUSD is a "buy" on a 3-6M horizon, though we anticipate a resumption of downside risks in the second-half of the year, towards the end of the Brexit transition window. But we certainly think that the 1.35-1.37 range in the pair is achievable beforehand, in the event of a "positive fiscal shock"," says Stephen Gallo, European head of FX strategy at BMO Capital Markets in a note to clients last week.

Wednesday's inflation and Friday's retail sales numbers will bekey in shaping market expectations of the BoE and the pathway trodden by Pound Sterling up ahead. So too will the Tuesday 21 jobs figures and the Friday 24 flash PMI surveys of the UK's three main industries from IHS Markit but arguably the greatest impact on the thinking of the MPC will come from the Wednesday 29 HM Treasury autumn forecast statement. 

Treasury's statement will reveal newly updated government forecasts for the economy up ahead as well as providing markets with a sneak peak at the March budget that's expected to see the new government of Prime Minister Boris Johnson splash as much as £60 bn worth of cash in order to get the economy going again. Pound Sterling will scrutinise the statement closely because any large stimulus might lessen the perceived need for rate cuts from the BoE. 

 

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