Pound / Euro Back Below 1.18
- Written by: Gary Howes
-
Image © Bank of England
Pound Sterling fell below the key 1.18 level against the Euro ahead of the Bank of England's November 04 meeting, with investors increasingly of the view policy makers will opt to forego a rate rise.
In this article we note analyst views that the recent declines in the value of Sterling in fact raise the prospect of a post-event bounce.
The Pound to Euro exchange rate had recently worked its way to the 1.19 level again amidst rising bets that the Bank will hike this month in a response to surging inflation levels.
"A month of hawkish Bank of England speeches, meantime, has stampeded money markets toward a possible UK rate rise as soon as this Thursday – and more than a full percentage point within 12 months. Such an early move had neither been warned of, nor bet on, as recently as August," says Mike Dolan, an analyst with Thomson Reuters.
But the exchange rate has since retreated into the mid-1.17s as pricing for a November rate rise is pared back, with investors instead looking to a December hike as now being more likely.
"A 5-4 vote to keep rates on hold at the MPC's November meeting is plausible, and we suspect that outcome would largely be a function of a few middle-ground MPC members wishing to wait for more post-furlough labour market data before committing to a hike," says James Rossiter, economist at TD Securities.
The Pound has retreated in tandem with this assumption.
- Reference rates at publication:
GBP/EUR: 1.1768 \ GBP/USD: 1.3630 - High street bank rates (indicative): 1.1540 \ 1.3348
- Payment specialist rates (indicative: 1.1710 \ 1.3562
- Find out about specialist rates, here
- Or, set up an exchange rate alert, here
"A rate hike in November but a semblance of caution in the manner in which it was delivered may cause the pound to slump as expectations of higher rates over the course of 2022 are unwound and front-end yields moderate," says Simon Harvey, Senior FX Market Analyst at Monex.
The concern for those wanting more purchasing power is that GBP/EUR becomes stuck below the 1.18 ceiling once more: we noted in October that the exchange rate struggled to break above 1.18 with numerous attempts to breach this level being met with selling interest.
There is however a chance that a good portion of those orders layered around 1.18 have since been burned out by the late-October break towards 1.19, however whether a swift return to 2021 highs occurs will of course depend on how the market interprets Thursday's Bank of England event.
Above: GBP/EUR daily chart.
Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.
TD Securities recently exited a bet that favoured Pound Sterling gains against the Euro, citing risks related to the Bank of England decision.
Specifically, they are wary the Bank is unable to deliver more than what's priced in by the market, "increasing the risks of a short-term correction".
The market anticipates a rate rise in 2020 - in either November or December - followed by further hikes in 2022 taking the Bank Rate to 1.0%.
Some economists judge this 'terminal' level as unrealistic and the Bank would not want to risk the economic recovery by hiking rates so drastically.
In short, the Bank is a first mover in the rate hiking cycle but could also be the first to exit, which is hardly an all-out bullish development for the Pound over a longer-term period.
But it does nevertheless offer some downside protection against a significant setback against the Euro.
Above: "Market pricing rapid UK rate hikes" - HSBC.
The European Central Bank remains resolute in maintaining a view that interest rates are not likely to rise until at least 2023/2024, and when they do come rate hikes will be gradual.
On this basis the interest rate story is one that is supportive of GBP/EUR, as noted by Rossiter:
"The carry cushion also means that EURGBP remains a sell on rallies ahead of the 0.86 level".
(Carry refers to the flow of capital from one a low interest rate area to a higher rate area, in this instance from the Eurozone to the UK. EUR/GBP at 0.86 equates to GBP/EUR at 1.1630.)
{wbamp-hide start}
{wbamp-hide end}{wbamp-show start}{wbamp-show end}
Pound Sellers Out in Force Ahead of Bank of England Meeting
The British Pound was sold heavily against the Euro and Dollar as markets bet the Bank of England would not deliver on lofty expectations.
Regular central bank watchers would note that the price action heading into a major policy call is typically reversed following the announced decision, regardless of what that decision is.
Therefore, a falling currency in the days heading into a decision can often rebound, by the same token a rising currency can go lower.
This is a "sell the rumour, buy the fact" or "buy the rumour, sell the fact" trade.
"It feels like a classic buy the rumor, sell the fact," says Rossiter of the Pound.
Above: "Speculative positioning has neutralised" - HSBC.
It must be noted Rossiter wrote his report on October 29 when the Pound was a good distance higher against the Euro, Dollar and other G10 currencies.
The Pound to Euro exchange rate has since fallen a percent over the past five days and the Pound to Dollar exchange rate is down by a similar amount.
The decline would suggest the Bank would need to deliver a decidedly bearish signal to push Sterling deeper into the red, increasing the odds of a rebound.
"The outcome of the BoE meeting looks no more than a coin toss. We have a bias to fade any significant Sterling weakness," says Paul Robson at NatWest Markets.
NatWest says a decision to hold off raising rates may be seen as “dovish” in light of significant moves in market pricing and Sterling could weaken on the announcement and recently closed a long running trade in favour of GBP/EUR gains.
But other currents are at play for the Pound which might ease downside pressures: last week saw a significant loosening of fiscal policy after the UK budget announcement proved more generous than expected on spending, which could support economic growth going forward and mitigate any negative impacts of higher interest rates.
NatWest also note UK-specific supply issues have continued to subside (gas prices have fallen sharply) and indications of a gradual, growth sensitive tightening cycle from Thursday’s meeting may prove to be ultimately Sterling supportive says Robson.