Pound Sterling Predictions vs. Euro and Dollar ahead of Bank of England Decision

- GBP to go lower on a 'bearish' hold
- Can go higher on a 'hawkish'cut
- GBP relief rally to be short-lived say BofA

Above: Governor Mark Carney makes his final appearance at an MPC event today. © Bank of England [2019]

- Spot rates at time of writing: GBP/EUR: 1.0808, -1.75% | GBP/USD: 1.1852, -2.15%
- Bank transfer rates (indicative): GBP/EUR: 1.0520-1.0596 | GBP/USD: 1.1537-1.1620
- Specialist money transfer rates (indicative): GBP/EUR 1.0650-1.0701 | GBP/USD: 1.1650-1.1745 >> More details

Key to the British Pound's near-term outlook will be the outcome of the midday interest rate decision announced at the Bank of England, an outcome which is too close to call and therefore offers the potential for heightened currency volatility.

Foreign exchange markets attribute a 50/50 chance of an interest rate cut, which leaves the Pound burdened by a degree of uncertainty and explains why it has traded with a softer tone over recent days.

The Pound-to-Euro exchange rate is flat at 1.1819 at the time of writing and the Pound-to-Dollar exchange rate is at 1.3015, as the key 1.30 support level continues to show its worth.

The general rule-of-thumb in the world of currencies is that when a central bank cuts interest rates, the currency it issues falls. At Thursday's meeting, because the market has sold Sterling as the odds of a rate cut have increased through the course of January, it therefore stands that the currency could recover in the event that the Bank keeps rates on hold.

"With market pricing for a cut finely balanced, this would suggest the risks to GBP through the MPC are asymmetric," says Kamal Sharma, FX Strategist at Bank of America (BofA).

But, anticipating the Pound's reaction is made a little more difficult in that nuances matter, and it might not simply be a case of a cut = a fall in the Pound, and a hold = a recovery.

The Bank will be offering communication and fresh economic forecasts which will have a bearing on the outlook and markets will therefore be afforded the chance to get a sense of what the Bank might do in future.

Above: The BoE's economic projections made at their previous inflation report. The BoE will be releasing fresh forecasts today.

Currency markets are by nature forward-looking and it could ultimately be the overall tone of the event that matters, indeed we could see some counter-intuitive moves in the Pound.

Stephen Gallo, a foreign exchange strategist with BMO Capital says he is looking for the possibility of a "hawkish 25bps cut" or a "dovish hold".

In other words, the Bank might cut rates but signal that this is a one-off move as the outlook for the economy has improved somewhat. This could see Sterling go higher in relief. In addition, the market might display a typical "sell the rumour, buy the fact" reaction and recover some of the losses seen over recent days.

A 'dovish hold' would see the Bank keep interest rates steady, but signal that outlook is murky and release some soft forecasts and leave open the prospect of a cut at their next major meeting in May.

This scenario could well see Sterling fall as market pricing for additional interest rate cuts grow.

Image courtesy of Bloomberg.

Robert Wood, UK Economist at BofA says "the path of least resistance for the BoE is rate cuts."

BofA expects an interest rate cut down to 0.50% to be delivered on Thursday, and any economic growth bounce to fade in the second half of 2020, or earlier, as the Brexit uncertainties caused by the tight deadline within which to reach an EU-UK trade deal dominates market attention.

Inflation is meanwhile expected by BofA to run well below target this year, suggesting the Bank has space within which to safely cut interest rates and not risk raising inflation.

"Whether it is now or in May we expect the BoE to cut rates, and follow up with another cut later in the year," says Wood. "We would not be expecting the BoE to cut interest rates based on this month's data alone. The PMI rebounded enough to keep the BoE's 1Q growth forecasts on track. The BoE could easily wait. Whether they cut or not is finely balanced, but recent BoE speeches suggest urgency."

If BofA are calling the Bank's thinking correctly, then the path of least resistance for the British Pound over the foreseeable future would almost certainly be lower, based on the rule-of-thumb that interest rate cuts = a lower currency valuation.

Even if the Bank does keep interest rates on hold, BofA's Sharma expects the Pound to remain under pressure, with any strength proving short-lived in nature and any respite for the Pound is therefore expected to be limited.

"We think any relief rally in Sterling will prove short lived as we believe markets are likely to roll out their rate cut expectations into the coming months. We continue to emphasise that the burden of proof remains on the data to drive GBP sentiment. So far, and outside of the housing data, the evidence of a meaningful rebound in confidence has been lacking," says Sharma.

BofA is tactically bearish Sterling in the short-term on "unfavourable seasonal factors and the lack of broad-based evidence of a pickup in activity."

Taking an opposing stance on Sterling's near-term future is BMO Capital's Gallo, he says the market is underpricing the impact of the Government's planned spending boost, which should become clearer in the March budget.

"FX investors still appear to be underpricing the likelihood of a much more dynamic and radical set of fiscal and economic policies in the UK. We continue to favour buying GBP/USD on dips below 1.30, and we still think there is room for additional downside in EUR/GBP over the coming 1-3M," says Gallow.

Gallo adds "FX investors should mostly look through the noise of any BoE "dovishness" that emerges from this week's rate decision."

"Spot may rally sharply on a hawkish surprise if future rate cuts are priced out with confidence," says Jacqui Douglas, Chief European Macro Strategist at TD Securities. Under such an outcome the Pound-Dollar exchange rate is forecast to rise to 1.3170, and the Pound-Euro exchange rate to 1.1947.

However, the base-case assessment at TD Securities is that the MPC votes 5-4 or 6-3 in favour of a 25bps rate cut today while 2020 GDP and CPI inflation forecasts are revised lower.

The message they expects that economic growth and inflation is expected to recover from here, and rate cut was for risk management. The BoE is expected to say they will watch the data before deciding on future moves.

Under such an outcome the Pound-Dollar exchange rate is forecast to trade down to 1.2905 and the Pound-Euro exchange rate to 1.1695.