Support for Pound Sterling against Euro and Dollar as Bailey hints Rate Cut no Done Deal

- GBP firms but remains vulnerable to further losses
- Bailey says rate cut dependent on further evidence
- Bank can cut before scheduled March 26 meeting

Above: Andrew Bailey testifies to the Treasury Select Committee on March 04. Image (C) Pound Sterling Live. Source: Parliament TV

- 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

The Pound is solidifying above 1.15 against the Euro and is creeping back to 1.29 against the U.S. Dollar amidst a stabilisation in global stock markets and fading expectations the Bank of England will slash interest rates this month.

Expectations for a rate cut by the March 26 meeting sit at around 50/50 according to money markets, after the incoming Governor Andrew Bailey told Parliament's Treasury Select Committee that he is waiting for more evidence on the impact of the coronavirus outbreak before voting to cut interest rates.

"What we need is frankly more evidence than we have at the moment as to exactly how this is feeding through," said Bailey.

The market pared back expectations for a rate cut as a result, at the start of the week expectations sat at around 65% for a cut, but they are now at 50%. "That was a wild day in interest rate markets. Mid-morning, investors were pricing-in a near-certainty of a 25bp emergency Bank Rate cut in the next wk. That's now seen as a 50:50 chance, following Bailey's comment that he wants "more evidence" of the virus impact before cutting," says Samuel Tombs, UK Economist at Pantheon Macroeconomics.

The Pound has proven to be particularly sensitive to shifting expectations for a rate cut at the Bank of England; in January the currency fell as markets increased bets the Bank would cut rates due to softening economic data. However, the Bank opted to keep an eye on the data, a decision that was justified by a subsequent uptick in economic activity.

If expectations for a rate cut start rising again over coming days we could well see Sterling pull back again. The Pound-to-Euro exchange rate fell sharply at the end of February, but Sterling has this week stabilised allowing the exchange rate to recover back to 1.1550. The Pound-to-Dollar exchange rate has also recovered ground and has recovered to a high at 1.2897.

However, in most instances Sterling looks to remain vulnerable to further downside and we would like to see a number of positive daily closes before suggesting a floor has been found.

Indeed, Bailey added that there was nothing to prevent the Bank from cutting rates before the officially scheduled March 26 meeting, a message that proved enough to keep investor expectations for a rate cut alive.

The decision will therefore be a finely balanced one.

"It’s evolving very quickly and it’s evolving in many ways in unprecedented and unexpected fashion," said Bailey of the coronavirus outbreak.

Bailey said authorities, "we are going to have to provide some form of supply chain finance in the not very distant future to assure that the effects of this shock from the virus are not damaging ... particularly to small & medium sized firms", it is however not clear whether that would come from the UK Treasury or the Bank of England.

He however said he as confident there would be close alignment between the treasury - which is responsible for government spending - and the Bank of England.

On the matter of Brexit, Bailey says it was important for the UK economy that the EU and UK agreed a free trade deal by year-end.

"My strong view is we should do all we can to get a free trade agreement with the EU and not fall back on the WTO," said Bailey.

That was a wild day in interest rate markets. Mid-morning, investors were pricing-in a near-certainty of a 25bp emergency Bank Rate cut in the next wk. That's now seen as a 50:50 chance, following Bailey's comment that he wants "more evidence" of the virus impact before cutting. pic.twitter.com/WFN7bVGrYs

— Samuel Tombs (@samueltombs) March 4, 2020

Deputy Governor of the Bank of England Ben Broadbent also hit the airwaves midweek and said the Bank of England is monitoring developments and is still considering its response.

Broadbent said the coronavirus will have a significant impact on the economy but that it could be a case that it is Government that is best placed to aid the economy in such scenarios.

Indeed, a major criticism of the Federal Reserve's emergency rate cut of 50 basis points on Tuesday as that it will actually do little to support the economy: where the financial crisis of 2008 was a result of structural imbalances and stresses in the global financial system, the coronavirus is most likely to hit the global supply chain.

Furthermore, it is likely to impact consumer confidence and drastically lower tourism spending. Labelling central bank actions as 'emergency' decisions will do little to convey a sense of calm to the public. "The playbook that we are sticking to is that COVID-19 case counts will continue rising, that the potent supply shock will become a just as potent demand shock as conferences, trips and events are cancelled, schools are closed and shelves are emptied," says Robert Rennie, a foreign exchange strategist with Westpac.

Broadbent adds that the economic impact of coronavirus will ultimately be temporary.

The evidence supplied by Bailey and Broadbent therefore confirms a rate cut is not a done deal.

We would expect the Pound to recover recently lost ground if the Bank holds rates and should global financial markets continue to recover.

Global Investors Turning More Confident

A key piece of the Sterling puzzle is the performance of global markets: when markets are falling, as was the case in late February, the Pound fell sharply.

Market recovery has meanwhile been met with Sterling upside. Key to the near-term outlook therefore is how expectations for Bank of England interest rates evolve and how global stock markets perform.

Global investors are increasingly confident as they react to news that a $8BN coronavirus support package has been approved by the U.S. Government, the market's reaction is understandable as I earlier mentioned coronavirus is most likely to be most effectively mitigated by government spending, not central banks.

"Tuesday’s tantrum is long past, and markets are repricing risk after the US doled out US$8bn in emergency funding for virus prevention, Joe Biden goes toe to toe with Bernie Sanders in the Democratic presidential race and the number of central banks providing accommodation grows," says Nema Ramkhelawan-Bhana, Economist at Rand Merchant Bank.

The size of the package approved by the senate is more than three times the size of the package proposed by President Trump last week.

Most Asian stock exchanges rose on Thursday with the Nikkei up 1.1%, Hang seng up  2.1% and the CSI 300 up 2.3%, following yesterday's rebound in the U.S. when S&P closed 4.2% higher. European markets are showing signs they will turn higher too.

However, we remain wary that the situation remains fluid and we therefore cannot say with confidence that stock markets will head higher in a straight line, which clearly has implications for Sterling now that it appears to be more aligned with global risk trends.

"Despite the strong U.S. rebound volatility continues to be high with new Corona cases reported in both Europe and the US. California state has declared state of emergency after the first Corona death was reported in the state, bringing the US death toll to 11," says Olle Holmgren, Chief Strategist Sweden at SEB.