GBP/EUR and GBP/USD Surge as BoE Squeezes Dollar ‘Mercilessly’

The British pound has powered higher on global currency markets following a Bank of England warning that markets are under-estimating the prospect of an interest rate cut in coming months.

Also Discussed Here: What elections? Currency markets show no interest in upcoming General Election

1.51 barrier will be a hard nut to crack for pound-dollar.

The past 24 hours belong to the UK currency thanks to revelations that interest rate rises are approaching.

For currencies the general rule of thumb remains that rising interest rates feed into a rising currency.

Bank of England Minutes, released in the London morning session, all but confirmed the next move on rates at the Bank is up.

• This pushed the pound to euro exchange rate (GBP-EUR) higher by 0.7% to reach above the 1.40 resistance zone once again.
• The pound to dollar exchange rate (GBP-USD) meanwhile powered ahead by a percent to reach 1.5061.

The USD and GBP are both outperforming the EUR on the observation that the Bank of England and US Federal Reserve will soon start raising interest rates (monetary tightening) while the European Central Bank is expanding its money supply via quantitative easing.

The pound sterling has suffered against the US dollar in recent months on the observation that the Bank of England may actually be pushing back its programme on interest rate rises while the US Federal Reserve is bringing their first hike forward.

This dynamic underpinned the GBP/USD decline, its influence may now be on the wane.

Markets Wrong-Footed

Money market rates went into yesterday pricing in the first rate increase at September 2016 while a Reuters poll of leading economists put the rate hike in the first quarter of 2016.

This may be too late warn the Bank of England via their minutes from the April decision-making meeting.

“Once again we have seen a unanimous vote from policymakers to leave interest rates unchanged. No big surprise there. However, two members saw the decision as "finely balanced", indicating that unanimity may not last for long,” says Enrique Diaz, Chief Risk Officer and Currency Expert at Ebury.

Diaz also thinks markets have picked up on a key admission:

“The BoE slipped a comment that seems to indicate markets are being too relaxed about the timing of upcoming rate hikes: ‘the path of Bank Rate expected by financial markets was now exceptionally flat’. In my opinion, this is driving a positive reaction in Sterling against its major peers.”

Pound to Dollar Exchange Rates Powers Through Resistance

The sterling dollar exchange rate has since powered through the 1.5000 level but stopped just short of 1.5050.

Boris Schlossberg of BK Asset Management says pound short were squeezed mercilessly throughout the morning.

“Still the 1.5000 barrier has proven to be a formidable resistance over the past month and with UK election still a big unknown further upside in the pair may be limited,” says Schlossberg.

The strength of the anti-dollar rally is going to depend on US data.

“Most of the recent moves in the majors are less a function of positive events at home and more a result of impatient dollar long liquidating their positions as the prospect of Fed policy normalization appears to move further and further away,” Shlossberg says.

Forget the UK Elections (For Now)

Another favourite theme amongst currency market commentators concerns the impact of UK elections.

Because the polls are so tight many in the industry see it fit to blame any fall in GBP on this uncertainty.

They are wrong. There is no evidence to suggest any recent moves are related to politics as yet.

It has been noted that the pound dollar exchange rate slipped by 3% in the last elections of 2010.

It is worth pointing out that the hung parliament was largely unexpected. This volatility may still come, but we see any bout of uncertainty only being delivered closer to the release of results.  

“Pre-election jitters in the UK are not feeding through to a weaker Pound yet, despite polls continuing to paint an uncertain picture of the outcome. It appears Labour have edged in to a narrow lead which, whilst it hasn’t had a prevailing effect on GBP up to this point, is not the favoured outcome for a Tory biased pound,” says Jonathan Pryor, Head of FX dealing at Investec.

We see the current price level in sterling as confirmation that a bottom may have formed on the GBP-USD rate.

The current moves will also go some way in convincing us that the longer-term rally in the pound to euro exchange rate is well and truly intact.