Wednesday, August 5, 2020

Will the BoE’s upcoming monetary policy decision result in sterling underperforming other major currencies?

  • Dollar
  • Pound
  • Bank of England


Analysts’ Pick: Will the BoE’s upcoming monetary policy decision result in sterling underperforming other major currencies?

  • A potential stall in the UK’s economic recovery, an expected spike in unemployment and deflationary pressure should tilt the BoE in favour of a dovish leaning statement, which consequently may put downward pressure on sterling on the announcement of the decision
  • Employment data in the US may undershoot economists’ estimates over the week and put some downward pressure on the dollar as investors may favour the Japanese yen or Swiss franc over the dollar as a safe haven currency
  • The net impact of a weakening dollar may tilt GBP/USD slightly towards the upside, but the currency pair is also expected to underperform the rest of the G10 basket of currencies over the week.

The Bank of England (BoE) is expected to announce its decision on monetary policy tomorrow at 2pm (GMT +8), but little changes to its policy is expected. Instead focus should be on the central bank's forecast, i.e. its update to its scenario analysis that it published in May. As a result, there should be a unanimous decision from policymakers to keep monetary policy unchanged at 0.1% for its key interest rate and 745 billion pounds for its asset purchase program. A reiteration of its commitment to support the British economy amid the immense pressure from the Covid-19 pandemic is likely as well, in line with other central banks over the past few weeks.

Overnight Index Swaps imply that financial markets do not expect a rate cut at tomorrow’s BoE meeting


That said, it is likely that the BoE will favour easing monetary policy later this year to help support the economic recovery in the UK. Signals that show developed countries' economic recovery stalling suggests that the UK is likely to experience a sharp rebound from Q2 in Q3 and possibly Q4, before the recovery starts to stall and only gradually pick up towards pre-Covid-19 levels. This is further supported by expectations for a dent in consumer demand as high unemployment levels for a prolonged period of time implicitly impacts the labour markets employability as well. This is due to companies starting to phase out jobs to cut costs and changing working conditions (in this case a shift to greater reliance on remote working environments) and as the labour market finds it more difficult to find new jobs as a result of non-transferrable skills.

Bloomberg’s daily activity factor model suggests that economic activity may have started to stall below pre-Covid-19 levels as the global economy continues to fight against the pandemic

08052020c_ta 08052020d_ta

UK’s unemployment figures is likely to experience another surge in the coming months with the British government starting to taper off its furlough scheme starting from August until the scheme ends in October


Revisions to its earlier forecasts for GDP looks likely as well. In May, the BoE forecasted an overall dip of 27% from Q4 2019 to Q2 2020. This was revised back down to 20% in June and is looking likely to be revised back up higher towards 23% as signalled by BoE Governor Andrew Bailey. Inflation will likely be another point of focus for the central bank after Chancellor of the Exchequer Rishi Sunak's summer budget statement thanks to the sales tax cut for the hospitality and tourism sector and subsidies for restaurant dining. Volatility in the oil and gas sector as well as expectations for a stall in crude oil prices is likely to render gas prices unable to offset the deflationary impact of those fiscal stimulus programs as well. As a result, we expect the BoE to revise its forecast downwards for inflation in Q3.

Negative rates unlikely to be ruled out but will probably remain as a last resort for the BoE. With rates at near lows and asset purchases already being expanded, the BoE will be looking at more options to provide more support to the economy. A number of tools remain, including yield curve control, more quantitative easing and negative interest rates. Cutting negative interest rates should remain at the bottom of the central bank's options since its likely to be less effective as compared to other options. Completely dismissing negative interest rates is also unlikely as it may oppose the central bank's interest and instead cause an unneeded perception of tightening monetary policy.

Sterling should as a result have room for some downside, possibly against the dollar depending on upcoming employment reports in the US. Employment data is set to be released this week but focus is likely to be on the benefit claims dataset. Private employment change and the official data set by the US Bureau of Labor Statistics looks likely to continue to show net additions of jobs to the overall economy. But both datasets may undershoot expectations as benefit claims for the period suggests that the pace of recovery in the job market was slowing. Initial benefit claims for last week may show another uptick, which would be the third increase in a row. This can be attributed to dampened sentiment in several industries that continue to be affected by the Covid-19 pandemic and since layoffs are likely to lag slightly behind the reintroduction of lockdown restrictions.

Spikes in both initial and continuing claims suggest that the spike in new Covid-19 cases increased layoffs while slowing hiring


Hence, the outlook for GBP/USD looks more likely to be only slightly tilted to the upside against the dollar. Employment data in the US is likely to put additional downward pressure on the dollar, as the greenback's safe haven properties has evidently started to decline among investors’ perception over the past couple of weeks in favour of gold, the euro, the Japanese yen and the Swiss franc. Additional dovishness from the BoE is also likely to put some temporary downward pressure on sterling and the net impact of both forces suggests that GBP/USD is likely to underperform in the basket of G10 currencies. In the short-term, GBP/USD may be able to fall slightly to reach 1.3048's level with a possible temporary selloff effect fuelled by the BoE's monetary policy decision. Over the week however, we still expect GBP/USD to rise against the dollar and retest 1.3155's level, which would bring Cable back to trade within its pre-Covid-19 levels in mid-March.

Technical Analysis:


Sterling bulls has benefitted from a net selloff in the dollar over the past two weeks. However, it does look like bulls are starting to lose steam following two days of gains in the greenback. A dovish leaning statement from the BoE may be the catalyst for the dollar to gain some momentum against the sterling, but it may only be temporary and could wear off at around the 1.2986 level. Potential downward surprises in US labour market data along the week may be able to lift GBP/USD possibly towards 1.3155’s level but is unlikely to break that level as a result of being a stronger support level due to it being the pre-Covid-19 trading price range for Cable.

Support: 1.3048 / 1.2986 / 1.2901

Resistance:  1.3155 / 1.3225 / 1.3286

GBP/USD Chart (H4)