British Pound Vulnerable to "Euro-like Drawdown" After Bank of England Rate Hike Warn JPMorgan

The Euro fell in the wake of the October ECB monetary policy event - the same fate could befall the Pound following the November BoE event warn JP Mprgan.

The Pound is seen rising against the Euro, Dollar and other G10 majors at the start of a new week in which the Bank of England policy decision forms the highlight for traders.

The rise in Sterling reflects the belief the Bank will raise rates for the first time in ten years, and suggest markets are perhaps expecting at least one follow-up rate rise in 2018. This question over subsequent moves on the interest rate is absolutely key as to whether or not gains can be sustained beyond Thursday.

If the Bank suggests this is a once-and-done move, then expect Sterling to fall back sharply, if further rises are communicated expect recent gains to be either maintained or built on.

It should come as no surprise then that the analyst community are basing their expectations for future moves in the Pound on the message delivered regarding future interest rate moves.

Hence, traders should bet against the Pound over the coming days argue strategists at JPMorgan who believe Sterling could be vulnerable to a sell-off like that seen last week in Euro-based pairs as likely-dovish commentary from policymakers may force markets to reassess the pace at which rates rise in the years ahead.

“The near complete pricing-in of next week’s BoE hike and the risk of dovish commentary in the wake of less-than-stellar cyclical dataflow leaves the pound vulnerable to a EUR-like drawdown,” says Arindam Sandilya, a strategist at the US-based investment bank.

The Pound has enjoyed a broad rebound against its G10 rivals over recent days after third-quarter GDP data showed the economy regaining some lost momentum, leading markets to price a 90% chance of a rate hike after this week’s Bank of England meeting.

Above: The Sterling-Euro exchange rate has been rising over recent days as markets bet 2018 will see at least one further interest rate rise.

“The latest GDP report was firmer than expected and reiterated the view that a rate hike will be delivered, but still in combination with the overall soft level of growth, uncertainty around the erosion of slack in the economy and no signs of building domestic wage pressures, we expect the BoE to deliver a cautious message alongside the rate hike,” says Sandilya.

Although the majority of economists and strategists expect the BoE to hike rates Thursday, many think it will be a mistake, while interest rate markets pricing currently implies an almost-50% chance of the BoE following up this week’s move with another rate hike in February.

“The number of dissents will be important to gauge the magnitude/speed of additional rate hikes. We expect a 7-2 vote for a 25bp hike, although 6-3 is possible (Ramsden and Cunliffe expected to dissent; possible from Broadbent and Tenreyro as well),” says Sandilya.

Sandilya and his team suggest current market expectations are too ambitious and forecast that, after Thursday, the Bank of England will keep the base rate at 0.50% till June 2018. UK policymakers are only likely to raise the bank rate again after that in December 2018.

“We continue to think that a less assertive BoE outlook is not the only factor weighing on GBP,” says Sandilya. “GBP valuations are no longer that cheap and talks on a transition deal to expected begin after the December summit should be a probable source of intermittent friction for GBP.”

Above: The Pound has seen choppy trade versus the US Dollar, but GBP/USD remains above the key 1.30 level.

Markets, and much of the commentariat, have spent the third quarter one edge over an absence of progress in negotiations between the UK and the EU.

“GBP isn’t a currency for high-conviction capital commitment for most investors in light of the complicated twists and turns in monetary policy and politics,” notes Sandilya.

JP Morgan’s team has recommended to clients they remain long EUR/GBP, which means they are betting on a fall in the Pound-to-Euro rate.

JP Morgan forecast the GBP/USD exchange rate to be at 1.33 by end-December, 1.33 by end-March 2018, 1.34 by mid-2018 and 1.36 by end-September 2018.

The EUR/GBP is forecast to rise to 0.90 by end-December 2017, 0.90 by end-March 2018, 0.91 by end-June 2018 and 0.92 by end-September 2017. This gives us a GBP/EUR exchange rate of 1.11, 1.10 and 1.09. 

Sterling was quoted 0.56% higher at 1.3194 against the Dollar shortly after noon Monday while the Pound-to-Euro rate was 0.52% higher at 1.1367.

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