Pound Tacks Lower Amidst pre-Bank of England Jitters

Above: File image of Bank Governor Andrew Bailey. Image © Pound Sterling Live, Still Courtesy of Bloomberg TV.

Pound Sterling continues to lose ground against the Euro in the run-up to Thursday's Bank of England decision.

Similar weakness has been seen in the days leading up to previous Bank of England decisions and speaks of investor nervousness of a Bank that has a tendency to err on the 'dovish' side. By this, we mean the Bank has often proven hesitant to raise interest rates when it needs to but is keen to cut rates at the first opportunity.

That first opportunity is coming closer, with the Bank of England's Governor and Deputy Governor recently giving speeches that raise the odds of a June interest rate cut.

"We still expect the European Central Bank and the Bank of England to lower rates in June," says Ben May, Director of Global Macro Research at Oxford Economics.

Although the market is fully priced for a June cut from the ECB, it only sees 50/50 odds of a similar move from the Bank of England; the Pound's recent weakness is a result of investors raising bets of such an eventuality.

Expect more losses tomorrow if market pricing moves more convincingly to the June start date, as a full repricing will demand a weaker Pound.

George Vessey, Senior FX Strategist at Convera says one-month euro-sterling risk reversals reached a fresh 6-month high amid bearish bets on the UK currency. "This means more traders are hedging against the risk of the pound depreciating against the euro as opposed to appreciating," he explains.

"We do not expect the recent data flow to prevent the BoE from delivering a more dovish policy signal this week indicating they are moving closer to cutting rates," says Derek Halpenny, Head of FX Research at MUFG Bank Ltd. "A more dovish BoE policy update poses downside risks for the pound in the week ahead."

The Pound to Euro exchange rate fell a third of a per cent on Tuesday as investors prepare for such a dovish shift from the Bank that will include another member of the Monetary Policy Committee voting for a cut, while inflation forecasts will be lowered in the Monetary Policy Report.

The statement will also potentially hint that risks are now balanced to downside surprises in inflation and there could also be a clear reference to the next move being a cut.

Paul Spirgel, a Reuters market analyst, says the Thursday announcement "may upset the applecart for sterling bulls." Though Reuters polling indicates traders expect interest rates kept on hold, nine out of 29 analysts polled project a second vote on the MPC to cut rates.

"Should the BoE vote be interpreted as a dovish hold... the April 22 low is back in focus," says Spirgel.

However, MUFG's Hardman says improving cyclical momentum for the UK economy and still supportive conditions for higher-yielding carry currencies should prevent a sharper sell-off for the GBP.

Shreyas Gopal, a strategist at Deutsche Bank, says a recent dovish repricing of the UK shorter-term bond yields over the past few sessions has left a cut by June half-priced.

Once the cut is fully priced, the selling can ease and we would not be surprised to see a "buy the fact" reaction by the Pound in the coming days.

Weakness against the Euro is likely to be limited as the European Central Bank is fully expected to cut interest rates in June, with further cuts likely in the coming months. With the two central banks likely to follow a similar path any outsized moves in Pound-Euro can be faded.