Pound Sterling "to Suffer" if Bank of England Discusses Negative Interest Rates

- GBP in the red ahead of Bank of England meeting
- £100BN in QE expected to be announced
- £200BN package could prompt GBP decline
- Warning of negative interest rates could prompt GBP decline

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The Bank of England looms large on the horizon for the British Pound - a likely reason why the currency is one of the worst performers in the midweek session - with analysts expecting an increase in the quantitative easing programme (QE) to the tune of £100BN. 

The Bank already announced a new QE programme of £200BN back in March and an additional boost would be a step up in the Bank's efforts to support the UK economy which is suffering a deep contraction owing to the covid-19 lockdown.

Not only is the market pricing in £100BN in additional quantitative easing, but that the basic interest rate is also left at 0.10%.

Risks to the currency would likely stem from the Bank announcing a package in excess of £100BN, or suggesting a further interest rate cut to 0% or below (NIRP) is possible in coming months.

"What may be more interesting than the size of the QE would be the discussion around negative rates. If they write off the discussion of NIRP then GBP can rally as there are about 10bps of cuts into Feb of next year. But if they show NIRP is a serious possibility in the near future that’s a big deal and GBP would really suffer," says Jordan Rochester, a foreign exchange strategist at Nomura.

At the time of writing Sterling is broadly lower against most of its rivals, something that could be interpreted as a sign markets are nervous of a GBP-negative surprise being sprung by Threadneedle Street: the Pound-to-Euro exchange rate is quoted at 1.1156, the Pound-to-Dollar exchange rate is quoted at 1.2514.

The green light to further intervention from the Bank of England came today following the release of inflation numbers that showed CPI inflation and fallen back to its lowest level since 2016, with the prospect of a rise back above 1.0% in 2020 looking relatively slim according to economists.

Indeed, some say the inflation rate could fall to 0%.

Inflation is perhaps a central bank's greatest constraint when it comes to cutting interest rates and printing money, and with all signs pointing to a period of protracted low inflation in the UK, the Bank of England will feel it has ample leeway to ease policy further.

The issue of negative interest rates was discussed by Bank of England members at various points in May in an apparent attempt to condition markets for a potential cut to below zero.

This talk, as well as rising Brexit trade negotiation anxieties, could have been a contributor to the Pound's underperformance in May.

However, the Bank pared back on the threat to go below 0%, with Chief Economist Andy Haldane hinting that such an outcome might not be necessary owing to signs of improvement in the economy.

Therefore, talk of negative interest rates has the potential to spook the markets and trigger potential losses in Sterling.

"We expect negative rates to be discussed amongst MPC members but eventually not needed and then 150bn of QE at this meeting," says Rochester.

Rochester says the Pound could undergo big moves if the size of the quantitative easing is much greater or larger than the £100BN the markets are expecting, particularly if a smaller £50BN package is announced (Sterling to go higher) or £200BN (Sterling to go lower).

Nomura are forecasting the Pound to grind lower against the Euro over coming weeks and have a forecast target of 1.0870 in mind.