Pound Sterling Today: Bank of England Ahead, Beware Hints Interest Rates will Fall Below 0%

- GBP steady ahead of Bank of England
- Declines likely if Bank signals rate cuts are coming
- Economists say rate cuts, QE boost likely in November

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• GBP/EUR spot: 1.0996 | GBP/USD spot: 1.2944
• GBP/EUR bank rates: 1.0788 | GBP/USD bank rates: 1.2682
• GBP/EUR specialist rates: 1.0897 | GBP/USD specialist rates: 1.2828
• Learn more about market beating exchange rates, here

The Bank of England forms the highlight for Pound Sterling on Thursday as any signal of imminent interest rate cuts or a boost to the quantitative easing programme could weigh on the currency.

Markets consensus expects the Bank to keep its policy rate at 0.1% with no changes expected to its quantitative programme that will see it buy up to £745BN worth of government and corporate bonds in order to aid the economy in these difficult times.

The risk for the Pound is that the Bank comes in more 'dovish' than expected and signals more easing is coming, as the general rule of thumb is that when a Bank eases monetary policy the currency it issues declines in value.

"With markets expecting a relatively benign outcome, we think there's some scope for a dovish surprise," says Sanjay Raja, Economist at Deutsche Bank. "Of most importance, will be what the MPC says - if anything - on the ongoing review of the effective lower bound (ELB)."

The effective lower bound refers to the lowest level the bank believes interest rates can be cut before they start becoming ineffective, i.e. pushing it below the ELB would effectively have little positive impact on the UK economy, if anything such cuts could hamper the financial system and create unwelcome risks.

Where the ELB lies is an important question for foreign exchange markets; markets would take it as a signal cuts to 0% or below are on the way if the Bank says the ELB is lower than the 0.10% it is currently set at.

"We think a decision on the ELB is near, and we should likely hear the outcome either at the August or September MPC meetings. When the decision comes, our view is the MPC will buy itself more policy space and lower the ELB marginally into negative territory," says Raja.

This would prove to be a substantial headwind for the British Pound which would likely fall under such a signal. The UK runs a sizeable current account deficit owing to the fact the UK imports more than it exports, a scenario that would typically result in a weaker Pound.

However, the Pound derives significant support from international investors attracted by the UK's investment opportunities. By lowering interest rates further international investors would be disincentivised from buying UK government bonds and investing in UK financial monetary assets, which would weigh on Sterling.

"For a currency with a significant current account deficit and deteriorating liquidity conditions, our view that GBP is entering another structural reset has been reinforced. We retain a medium-term bearish view towards GBP but remain cognisant of a potential relief should a deal be struck between the EU and UK," says Kamal Sharma, FX Strategist at Bank of America Merrill Lynch.

Ahead of the September policy event, we see the Pound-to-Euro exchange rate trading at 1.0982, the Pound-to-Dollar exchange rate at 1.2942 and the Pound-Australian Dollar exchange rate at 1.7768.

"We see risks of more dovish minutes as a result and continue to look for the BoE to extend QE by £100bn in November and cut Bank Rate to zero. We have more conviction on the timing of the former than the latter," says Robert Wood, UK Economist at Bank of America Merrill Lynch, who adds a cut to -0.50% would be likely in the event of the EU and UK failing to agree a trade deal.

Economists widely expect the Bank to take a cooler approach to the economy, moving away from observations made during the summer months that a strong v-shaped recovery was underway.

Should the Bank note headwinds to the recovery have since grown - namely because of rising covid-19 infections and heightened Brexit trade negotiation tensions - expectations for quantitative easing or a cut interest rates will grow.

Such a view on the economy would likely be a negative for Sterling as markets will read this as conditioning for lower interest rates over coming months.

"Mechanical lockdown easing gains are mostly in the past and the pace of recovery has begun slowing. Indicators suggest it will slow further in coming months. We see downside risks to our forecasts as COVID-19 cases pick up, the government withdraws fiscal stimulus and Brexit takes its toll again. So, we see a strong case for more BoE stimulus later this year," says Wood.

The Bank in June announced an expansion of its quantitative easing programme by £100BN, which it expects to have fully utilised by year-end.

This amounts to a purchase run rate of around £6.9BN a week until August 06 and most economists agree that given the risks to the economy the Bank won't let the programme come to an end.

"We expect the BoE, at a minimum, to extend QE by £100BN in November. We can see no argument for allowing QE purchases to end on its current scheduled date of December. More tentatively, we expect the BoE to cut Bank Rate to zero in November, maximising monetary stimulus without crossing the Rubicon of negative rates. However, given the downside growth risks we see, if the BoE does not cut Bank Rate to zero in November, we expect it to do so in 2021. In the no-deal Brexit scenario, we expect Bank Rate cut to -50bp," says Wood.

This leaves the November meeting a 'live' event where further quantitative easing measures and rate cuts would likely be announced. The risk for Sterling is that these moves are 'priced' into the currency today, and over coming days, in anticipation of November's decisions.