Cable has been hit by a one-two punch over the last week or so. Tomorrow is a barrage of economic data that might help revert the situation, at least for a bit. On the other hand, if the data disappoints, then there could be renewed downward pressure.
The main incidence is that up until recently, the thought was that the Fed would ease faster than the BOE. Even the ECB was expected to ease faster than its British counterpart. This left the pound relatively strong. But the latest data out of the US has caused a rethink of the Fed outlook, and now investors are starting to wonder about the BOE, as well.
Down and Again
Last week’s US NFP were a major catalyst for the markets, with expectations of a double rate cut at the next meeting being wiped off. In fact, now just 82% of traders expect the Fed to cut at all. Then on Thursday, headlines came out about BOE Governor Andrew Bailey suggesting that his institution could be “a bit more aggressive” in rate cuts, and that pushed the pound down even more. Futures markets are now saying that there is a 97% chance of a rate cut at the next BOE meeting.
At the moment, the interest rates in the US and in the UK are practically the same. The future projections, therefore, mean that there is a risk of an interest rate gap between the GBP and USD that would hurt the pound. So, cable has to fall to meet that cost of risk.
But How Sure Is It?
Despite the markets moving on the Bailey headline, a closer look at his comments reveals that there wasn’t much change in his position. All he said was that if inflation were to fall faster than currently estimated, then the BOE would cut rates faster. Which is as close to saying water is wet as a central banker can get. He also said that inflation could increase in the coming months due to higher energy prices from a potential flare up in the Middle East.
The BOE’s Chief economist, Huw Pill, spoke a day later, sounding significantly more hawkish. Though he also did vote against the first rate cut that the BOE did back in July. Meaning that it seems the market moved more on hope of a rate cut than any change in the fundamentals pointing to one. And that’s where tomorrow’s data becomes key.
Making Room for Cuts
Monthly UK August GDP is expected to come in at 0% for the second month running. An essentially stagnating economy gives little headroom for the central bank to keep rates higher. So, if there were a surprise uptick in economic growth, then the pound could recover as it would mean that the BOE won’t be as pressured to cut. On the other hand, if there is another surprise to the downside in growth, a monthly negative read would put more pressure on the BOE to ease.
Markets are also paying close attention to commentary on the upcoming Budget, to be released at the end of the month. This would be the first Labour budget in more than a decade, and naturally there is some anticipation about what kind of changes there will be. The talk about raising taxes, and changing debt rules to allow more spending on infrastructure, are likely to be understood as inflationary. That would potentially keep the BOE at the higher end of the interest rate range.
