Sterling "Hit Hard" by BoE Surprise

Pound Sterling's near-term outlook against the Euro and other currencies has been curtailed by Thursday's decision by the Bank of England to forego raising interest rates. But a strong jobs report due mid-month could reignite support.

Above: Bank of England Governor Andrew Bailey fields journalist questions following the November MPC meeting.
Image (C) Pound Sterling Live, still courtesy of the Bank of England.

Pound Sterling has dropped in value as markets lower their expectations for future UK interest rate levels following the Bank of England's November policy update.

A decision to keep interest rates unchanged wrong footed markets which had raised expectations for a November hike to a 100% certainty by late October, positioning that supported the Pound in the process.

This 100% certainty was consistent with the Pound-Euro exchange rate's 2021 high at 1.19 on October 26; but this certainty gradually waned and so did the Pound.

Expectations for a hike were nevertheless still elevated by the time Thursday's decision came around, with a December hike seen as certain in the event that the Bank opted to forgo a rate hike.

But the Bank effectively pulled the rug from beneath the market by suggesting a December hike might also be off the table,

"The pound has been hit hard," says Josh Mahony, Senior Market Analyst at IG, "the fact that markets had been pricing in a 62% chance of a rate rise today has resulted in a sharp move lower for the pound."

Above: GBP/EUR at four hour intervals.

• GBP/EUR reference rates at publication:
  Spot: 1.1683
• High street bank rates (indicative band): 1.1374-1.1456
• Payment specialist rates (indicative band): 1.1578-1.1625
• Find out more about specialist rates, here
• Or, set up an exchange rate alert, here

The near-1.0% fall in the Pound to Euro exchange rate on Thursday is the largest one-day decline since September 28 and materially dents the outlook for the pair from a technical perspective.

But back in September the Pound soon found its feet again and rallied hard.

Will Thursday's decline ultimately fade over coming days and then give way to a rally similar to that of September?

Much depends on how bond markets react from here and to what degree investors can rebuild their confidence in the Bank of England's forward guidance; after all confidence will have been shaken by this surprise.

The move lower in interest rate hike expectations saw UK bonds bought which meant the yield they offered fell sharply, with the ten year UK government gilt now yielding below 1.0% again:

Above: The yield paid on ten-year UK government gilts declines.

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Declining yields ease global investor demand for UK bonds and in the process deprives the Pound of a source of demand.

The market not only expected a 2021 rate hike heading into the November meeting but they also expected notable hikes in 2022, with the Bank Rate being seen as high as 1.10% by June 2022 according to money market pricing.

But these lofty expectations have certainly now been tempered by a Bank of England which made it clear that such tightening of monetary conditions was not warranted.

Economists remain of the view that a December or February hike is still possible, which could ultimately arrest declines in the Pound.

"The MPC made clear that a rate hike was coming soon, though it also sent a clear message that the pace of tightening was likely to be much less aggressive than markets anticipate," says Andrew Goodwin, Chief UK Economist at Oxford Economics.

"Whether the BoE hikes in December or February is finely balanced," says Goodwin.

Oxford Economics favour February as lift-off date on the basis that there’ll be little hard evidence on the impact of the end of the furlough scheme by the December meeting.

They continue to expect one further rate hike next year, taking the Bank Rate to 0.5% by the end of 2022.

The Bank said the delay to raising rates rested with a desire to see the impact of the ending of the government's job support scheme (furlough) at the end of September.

Therefore whether lift off happens in December could rest with November's job report covering the October period.

HMRC data released ahead of the Thursday Bank of England decision revealed that at the scheme's close on September 30 410K employers were being offered support, who had a total of 1.14 million jobs on furlough.

This is a decrease of 210K from 31 August when there were still 1.35 million jobs on furlough.

Meanwhile, survey data from Lloyds Bank suggests 60% of businesses with furloughed workers would welcome back all furloughed staff.

This survey data was backed up by a fortnightly business survey from the ONS which showed by late October 87% of furloughed employees returned to work, 3% were made permanently redundant, 3% voluntarily left their role and 8% were classified as "other".

The labour market report of November 16 is likely to show figures consistent with a labour market healthy enough to sustain a small interest rate rise from off its crisis-era floor.

A strong jobs report could therefore reignite support for the Pound, but until then sellers look to be in command.