Bailey Blunts Sterling's Recovery

- GBP softer on Bailey comments regarding -ve interest rates
- Nerves heightened over looming Brexit update
- Ireland's Coveney says talks could last until year-end
- But beware 'buy the rumour, sell the fact' on trade talks says Nomura

Above: File Image of Governor Baiely © Pound Sterling Live, Still Courtesy of Bloomberg TV.

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The British Pound's recovery against the Euro, Dollar and other major currencies was stopped after markets reacted to comments by Bank of England Governor Andrew Bailey on the prospect of UK interest rates turning negative in the future, while a looming update on Brexit trade negotiations will increase nerves.

Bailey said at a virtual event hosted by Queens University in Belfast that the MPC has an open mind about whether and when to cut the basic Bank Rate to zero or below.

Foreign exchange and money market reactions suggest some investors have interpreted a shift in stance by the Governor, from being firmly against negative interest rates to one that is perhaps more open to such a move than might have been previously the case. 

At the very least, the market reactions and analyst interpretations confirm the incredible levels of nuance involved in interpreting and trading central bank commentary.

Markets are highly attuned as to where UK interest rates are heading and the interpretation that the Bank's Governor is not ruling out a cut to 0% or below as forcefully as might have been the case in the past is seen as confirmation that another cut is coming, by mid-2021 at the latest. The Pound tends to fall when expectations for future interest rate cuts start to increase, or the timing of a cut is brought forward.

The Pound-to-Euro exchange rate was as high as 1.1037 on Tuesday but has since pared back to 1.0941 in mid-week trade. The Pound-to-Dollar exchange rate went as high as 1.2900 before paring back to 1.2837.

"If redundancies surge when the furlough scheme end in October, this will inevitably lead to demands that the government is not doing enough to support the economy. More fiscal stimulus in the UK in the coming months could bring some support for the pound. However, if the Chancellor appears reluctant to spend, GBP could be exposed to more downside risk since it may increase the pressure on the BoE for further policy action," says Jane Foley, Senior FX Strategist at Rabobank.

Bailey reiterated a view that cutting interest rates to negative would require a notable deterioration in the data and the bar to the kind of economic slump seen in the first half of 2020 is incredibly high and unlikely to be repeated.

Indeed, some commentators have said Bailey has been nothing but consistent in his view that negative interest rates are unlikely to be delivered, and that perhaps the market's reaction to his comments will therefore prove to be short-lived.

The Bank's Chief Economist Andy Haldane has meanwhile said on Wednesday that rising expectations for negative interest rates are unwarranted in the current economic climate, saying that the market's rising bets for further cuts following the September Bank of England policy meeting should not be mistaken as a signal to the likelihood of such an outcome.

Markets raised their bets for a rate cut and sold Sterling after the Bank said in the minutes of its September meeting that it would engage regulators on the matter of negative interest rates in the fourth quarter.

Haldane has maintained an upbeat tone on the UK's economic recovery and given his record on the economy and views on negative interest rates stands as a significant hurdle to further interest rate cuts.

How Sterling navigates the remainder of the week will almost certainly depend on the outcome of the ninth and final round of trade negotiations between the UK and EU in Brussels, scheduled to conclude on Thursday.

The chief negotiators are expected to brief the press following the negotiations and while no breakthrough is expected a Sterling-positive outcome would be an acknowledgement that some progress has been made and that discussions would be ongoing. This could well signal that a 'tunnel phase' of negotiations is being entered into, where negotiators hone in on the final and outstanding issues in complete secret.

Typically, such a stage would be expected to deliver the kind of breakthrough required to put a deal before EU leaders at the mid-October European Council summit which has been set as something of a soft deadline by both sides.

A Sterling-negative outcome from the briefing would however be one where both sides confirm not enough progress has been made to further discussions and they official negotiations have all but ended in deadlock.

What happens next would be unclear, creating the uncertainty that tends to result in lower Pound exchange rates.

Sentiment regarding negotiations has improved over the past ten days, driven by a series of positive unofficial press reports that suggested both sides were still intent on finding a deal despite a deterioration in relations during the first half of September. Most foreign exchange analysts and economists we follow remain of the belief that the two sides will ultimately strike a 'skinny' trade deal before the year ends.

"There is no smoke without fire. Positive mood music in Brexit talks drove GBP higher ... as a result, we close out our GBP shorts for the time being. We are not flipping to a long position or becoming materially optimistic on GBP," says Jordan Rochester, foreign exchange strategist at Nomura.

With an improvement in sentiment has come a recovery in the Pound, but the recent set back to the rally should see the currency maintain current levels until a more concrete steer on the direction of negotiations is forthcoming. 

"This is likely to prove a tough week for trading GBP. In the short term, the market looks to be pricing in a potential Brexit deal, and GBP is over 1% higher on it. But there is a lot to think about beyond that. We can’t help but see a Brexit deal as a 'buy the rumour, sell the fact' moment," says Rochester.

Ahead of the completion of the final round of negotiations, Ireland's Foreign Minister Simon Coveney said he saw a "good chance" of a trade deal between the European Union and the UK, with his comments being interpreted as his most upbeat note over the prospects for an accord since a controversy erupted over Prime Minister Boris Johnson’s plan to to re-write the Brexit withdrawal agreement.

"The obstacles are not insurmountable" to an agreement before the end of the year, Coveney said in an interview with Bloomberg Television on Tuesday. "Not agreeing a trade deal would be an enormous failure. The stakes are very high here."

Coveney said that the October 15 summit of EU leaders would not be a deadline for the EU, suggesting there is scope for talks to extend into November.

"While we are still several weeks away from a realistic deadline, it is too soon to expect either side to signal a deal is close and GBP is vulnerable negative headlines in the short-term," says Adam Cole, Senior FX Strategist at RBC Capital Markets.