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British Pound Firms against Euro and Dollar Aided by Bailey Comments and Stock Market Recovery

- GBP/EUR finds a base just below 1.15
- We see no potential catalysts for major recovery
- Incoming BoE Governor Bailey hints not ready to cut rates

Euro exchanage rates

Above: File photo of incoming BoE Governor Andrew Bailey. Image © Simon Thompson, ICAEW. Accessed Flickr, reproduced under Creative Commons licensing.

- GBP/EUR spot: 1.1529, +0.52%
- Bank transfer rates (indicative): 1.1225-1.1306
- FX specialist rates (indicative): 1.1370-1.1425 >> More information

The British Pound found itself better supported in mid-week trade amidst a recovery in global stock markets and hints by the incoming Bank of England Governor Andrew Bailey that an interest rate cut this month is not yet a done deal.

Bailey was scrutinised by lawmakers in the UK's Parliament where he defended his credentials for the job and gave markets their first hint as to how he might approach monetary policy over coming days and months.

"What we need is frankly more evidence than we have at the moment as to exactly how this is feeding through," said Bailey, referencing the impact of the global coronavirus on the UK economy.

While not an explicit endorsement for keeping interest rates at 0.75% Bailey certainly did not hint that the Bank of England would follow other major global central banks into an interest rate easing cycle. Over the past two days we have seen the Reserve Bank of Australia, the U.S. Federal Reserve and Bank of Canada all cut interest rates, with markets expecting the European Central Bank and the Reserve Bank of New Zealand to follow suit later this month.

The incoming Governor will find himself under pressure to follow suit in solidarity with the global response to the virus outbreak, and money market pricing suggests investors are still convinced rates will be cut at Threadneedle Street this month. Bailey will oversee his first Monetary Policy Committee meeting on March 26 and will replace outgoing Governor Mark Carney mid-month.

The standard FX playbook says a currency tends to fall when its issuing central bank enters a rate cutting regime and much of the Pound's weakness in late February and early March has been put down to rising expectations for an interest rate cut at the March 26 policy meeting.

The Pound-to-Euro exchange rate lifted itself off the floor and went back above 1.15 to quote at 1.1535 at the time of writing.

The Pound-to-Dollar exchange rate is at 1.2837, having been as low as 1.2738 earlier in the week.

While Sterling has found some strenght, gains are still yet to convince that a meaningful turnaround in fortunes for the heavily sold UK currency is about to transpire.

The Pound suffered substantial losses in late February and early March which appear to be linked to a sell-off in global stock markets, owing to the currency's heavy reliance on the inflow of foreign investor funds for support. When markets sell-off in aggressive fashion inflows of foreign funds tends to dry up, exposing the currency to downside pressures.

We have nevertheless seen Sterling find some support against a host of other currencies this week as the global market sell-off fades amidst investor hopes for a substantial support package from the world's largest central banks.

Pound to Euro exchange rate

However, there is now a paradox for Sterling as a result: central banks are offering support to the currency via stabilised stock markets, yet at the same time growing expectations for a rate cut at the Bank of England are exerting downside pressures.

Bank of England Governor Mark Carney told lawmakers in the UK Parliament on Tuesday that international policy makers are preparing a “powerful and timely” response to any the negative effects posed by the coronavirus outbreak to the world economy.

Despite Bailey's hints at the Treasury Select Committee, markets believe the Bank's Monetary Policy Committee still stands ready to cut interest rates at the March 26 meeting.

Carney said the MPC was "considering the policy implications of various possible scenarios" that could arise from the outbreak of the coronavirus.

He added the persistence of any economic hit arising from the viral outbreak should be different to that of the "lasting scarring" caused by the financial crisis in 2008 and that coronavirus is likely to cause "disruption not destruction".

Carney added that the Bank was currently in the process of changing its assessment for the UK economic outlook suggesting the potential for a further downgrade to UK growth forecasts for 2020, which currently stand at just 0.8%. "It's hard to imagine they are revising the forecast up," says James Rossiter, Head of Global Macro Strategy at TD Securities. "We expect the Bank of England to cut Bank Rate by 25bps at each of its March and May meetings. The situation remains highly fluid, especially as we await any possible fiscal policy response."

Ultimately therefore, the Pound-Euro exchange rate now finds itself in an environment where there is little fundamental support for advances towards the upside and we would expect further consolidation around current levels.

Foreign exchange markets will today turn their attention to the appearance of incoming Bank of England Governor Andrew Bailey who is scheduled to testify before the Parliament’s Treasury Select Committee mid-morning.

As the new Governor Bailey will likely set the tone for the MPC and could therefore be instrumental in deciding whether the Bank cuts interest rates or not this month.

We however have little insight into how Bailey thinks when it comes to cutting and raising interest rates; will be prove himself to be a Governor who errs on the side of caution and cuts interest rates on signs of a slowdown, or will be prove to be one that needs clear and conclusive evidence that the economy is in need of an interest rate cut.

After all, at 0.75%, there is a limited amount of room to cut interest rates at the Bank of England.

Bailey should give some strong clues as to which side of the fence he sits when he appears before lawmakers and his appearance could therefore have a notable impact on the value of Sterling.

Should Bailey suggest he does not see an interest rate cut as being necessary, and that further economic data is required, then we could well see the British Pound recover some ground. However, if he signals that he believes a rate cut is indeed necessary to mitigate any negative economic shocks stemming from the coronavirus then Sterling could fall further.

"We now expect the BoE to cut the bank rate by 25bp to 0.5% at its upcoming 27 March meeting. It will also probably signal that it could begin to buy bonds (QE – quantitative easing) if economic risks increase further. Further out, we see a 40% chance that the BoE could announce a further rate cut at the 7 May meeting. If the BoE does not announce any QE alongside its rate cut on 27 March, any further cut in rates in May would probably be reinforced by a round of QE," says Kallum Pickering, Senior Economist at Berenberg Bank in London.

The U.S. Federal Reserve meanwhile delivered an emergency interest rate cut on Tuesday; days ahead of the next scheduled Fed meeting which is due next month. The move was designed to provide a decisive and proactive response to the economic threats posed by the coronavirus.

Could the Bank of England take a page out of the Fed's textbook and cut rates before the scheduled March 26 MPC meeting? We would suggest to readers that this is a real possibility that could inject some unexpected volatility into Sterling.

"We now think the MPC will cut Bank Rate to 0.50% this month, from 0.75%, and would not rule out the move coming at an emergency session, before the next scheduled meeting on March 26," says Samuel Tombs, UK Economist at Pantheon Macroeconomics.

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