Bank of England to Cut, not Raise, Interest Rates Next and the Pound "Will Continue to Sell Off Hard" as a Result

- "GBP will sell off hard" says Mizuho dealer

- Slowing data, hard-Brexit to both prompt an interest rate cut at Bank of England

- "Sterling is under attack on all fronts" says Commerzbank analyst

Above: The Bank of England, Threadneedle Street, London. Image © IRStone, Adobe Stock

Those with foreign exchange purchases have been warned that Pound Sterling could "sell off hard" as the Bank of England cuts interest rates by 0.25% in coming months.

Neil Jones, a foreign exchange dealer with Mizuho Bank Ltd. in London, believes the next move at Threadneedle Street may be a cut, and not the increase in interest rates the market is expecting.

This is a remarkable call, particularly considering it comes just one week ahead of the Bank of England's May policy meeting, an event that until recently was widely expected to see the Bank raise interest rates by another 0.25%.

The call has significant implications for the outlook of the British Pound which has been closely correlated with Bank of England policy expectations during 2018, rising as expectations for interest rate rises increase, and falling when those expectations pare back.

Official data shows the UK economy to have barely grown in the first three months of 2018 which appears to have dented expectations for an interest rate rise with markets noting that the Bank risks smothering growth yet further if it pushes up the cost of borrowing.

Jones' note comes on the day that the services PMI for April was released by IHS Markit with data showing the all-important services sector failed to shake-off the weather-inspired slowdown of the previous month; the implication being that the economy is suffering a more broadbased slowdown.

For Jones, it is not only the softer data pulse the Bank will be eyeing, in fact it is the potential disruption posed by Brexit that presents the most significant consideration to Bank of England policy expectations, and by extension, Sterling.

"My sense is given the current state of play on Brexit negotiations, the MPC may well hold off until after March 2019 exit deadline ruling out any increase for 2018," says Jones. "With much uncertainty likely to weigh on consumer & business confidence, GBP will sell off hard."

The MPC did not hesitate to cut interest rates post the referendum, and Jones estimates "they will vote to keep the powder dry in case a repeat cut is required."

"The Pound will continue to sell off as the expectation shifts to no cut this year with a further sell off on a shift to a cut following a no deal hard-brexit after March 2019," says Jones.

We have contacted Jones for the levels he expects the Pound-to-Euro exchange rate and Pound-to-Dollar exchange rate to ultimately test on such an outcome, and will update should they be made available.

This pessimistic outlook is shared elsewhere in the analyst community, "Sterling is under attack on all fronts at present: disappointing economic data, doubts about the BoE rate hike next week, political disagreements and questionable news on the Brexit negotiations," says Antje Praefcke at Commerzbank.

The new round of negotiations with the EU started this week and Praefcke flags it as being notable that EU chief negotiator Michel Barnier, who travelled to the Irish border, pointed out twice over the past few days that it is also possible that no deal would be reached.

"This may be just part of his negotiating tactic to finally get the British government to commit to clear statements on how it envisages its future relation with the EU (including the Irish border). But in any case it should constitute a warning signal for all Sterling bulls," says Praefcke.

The key risk for Sterling is that Brexit negotiations involve a substantial amount of issues that must be surmounted and both the EU and UK acknowledge that nothing is agreed until everything is agreed.

"The clock is ticking more loudly and quickly than ever," warns Praefcke.

Strategists at London-headquarter global multinational Standard Chartered have meanwhile told clients they believe the Pound's strong run at the start of 2018 is unlikely to be repeated and they "believe long-term uncertainties regarding a Brexit deal are likely to continue to restrict significant further gains in the GBP."

Analysts cite recent weaker UK data and comments from BoE governor Carney as highlighting that the rate hiking trajectory is unlikely to be smooth.

"As a result, we believe the GBP could trade in a broad range," say Standard Chartered.

Sterling could find itself particularly vulnerable to a muddle against the Euro with Robin Wilkin, an analyst at Lloyds Bank Commercial Banking, saying the prospect of a intractable sideways trading is preferred, noting the GBP/EUR exchange rate to be "consolidating mid-range".

"Our studies suggest that we are likely to further develop in the range before an extension," says Wilkins, who is actually erring on the side of Sterling, eyeing a potential move back to the highs in the 1.18 region.

A move through 1.15 and 1.1520 would signal to the analyst the possibility of a re-test of channel resistance in the 1.1590 region, a subsequent break here opens a greater decline towards 1.17.

Concerning the Pound-Dollar exchange rate's outlook, Wilkin says the pair has reached an important short-term juncture around 1.3550.

"This area is seen as strong support and that combined with a number of other technical indicators suggest a rebound from this region can be seen, data willing. Below there, next supports are around 1.3300. While over 1.3550, we look for a move back to 1.3750-1.3805, and then see if a lower high develops," says the analyst, in a briefing dated May 3.

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