Pound Claws Back Carney-Lead Losses

- Carney hints of potential for interest rate cut

- Comments catch FX markets off guard

- But rate cut is by no means guaranteed

- UK data could improve in Q1 2020

- Spot rates: GBP/EUR: 1.1779, +0.13% | GBP/USD: 1.3086, +0.13%

- Indicative bank rates for transfers: GBP/EUR: 1.1467-1.1550 | GBP/USD: 1.2730-1.2819

- Indicative money transfer specialist rates: GBP/EUR 1.1600-1.1670 | GBP/USD: 1.2950-1.3020 >>Get your quote now

The British Pound is on Friday recovering some of the ground it lost in the wake of comments from Bank of England Governor Mark Carney, with analysts saying the Governor's intervention on the outlook for UK interest rates should have little long-lasting impact on the currency.

Carney said in a speech at a Bank of England research workshop that the Bank stood ready to deliver a "prompt" response to weakness eyed in the UK economy over recent months; a signal to markets that an imminent interest rate cut could be at hand.

The rule-of-thumb in currency markets is that when a central bank engages in interest rate cuts, the currency it issues loses value.

Samuel Tombs, UK Economist at Pantheon Macroeconomics says the following sentence "appears to have just knocked about 0.5% off GBP":

"There is a debate at the MPC over the relative merits of near term stimulus to reinforce the expected recovery in UK growth and inflation."

Markets had been expectant of an interest rate cut in 2020, however they had expected it to come at some point later in the year. Carney's comments have brought forward those expectations and sent the Pound lower accordingly.

"We knew they were debating stimulus last month, when two MPC members voted to cut rates. This is not news. But the Governor knows what kind of reaction he will get by mentioning the stimulus debate; clearly he at least still is wavering, despite the election result," says Tombs.

The Governor, who ends his spell at Threadneedle Street this year, added that the recovery in the UK economy predicted by economists at the Bank was by no means assured.

Nevertheless Carney said that with relatively limited space to cut the Bank's interest rate from 0.75%, if evidence builds that the weakness in activity could persist, risk management considerations would favour a "relatively prompt response."

"Currently, there is insufficient conventional policy space based on past experience.... All told, a reasonable judgement is that the combined conventional and unconventional policy space is in the neighbourhood of the 250 basis points cut to Bank Rate seen in pre-crisis easing cycles," said Carney.

"The market seems to think Carney’s comments mean that the idea finds wider support amongst MPC members than previously assumed. The market is nonetheless only pricing in a 50/50 chance of a rate cut this year. We, on the other hand, consider a rate cut before mid-2020 to be likely, which is why we forecast further Sterling depreciation," says Thu Lan Nguyen, FX & EM Analyst at Commerzbank.

Above: Sterling fell sharply in the wake of comments from Carney, but has since been recovering those losses as markets digest the intervention.

The intervention of Carney in this manner is surprising in that it comes so soon after the December General Election, with hints suggesting the decisive outcome in favour of the Conservatives has unlocked a degree of confidence amongst UK businesses.

We would have expected Carney to issue such statements after having observed the data out in the first quarter of 2020 to gauge whether or not there is a 'Boris bounce' effect taking place in the economy.

This week's Services PMI release showed that firms reflected an increased level in confidence on the outlook following the decisive win for the Conservatives, while Halifax house price data showed UK house prices posted their strongest monthly increase in nearly 13 years in December with a +1.7% month-on-month, taking the year-on-year increase to 4%.

Anecdotal evidence from the property market suggested that there was an almost instant pickup in interest in the housing market following the election result.

Of course there is still no 'hard' data reflecting any post-election bounce in the economy, but if a pickup is registered in data in the first quarter of 2020, the Bank of England will find it difficult to justify why the UK economy requires an interest rate cut.

The Pound would find itself supported under a scenario where the Bank rows back from its 'dovish' stand and starts pointing to signs of improvement.

"Nothing has changed," says Viraj Patel, FX & Global Macro Strategist at Arkera. "UK data & prevailing Brexit politics will drive policy (both better). Bar is high for a BoE cut given limited policy space (whole premise of Carney's speech). GBP/USD attractive at 1.30."

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