Pound-Dollar Exchange Rate Hits 5-Month Best Following Bank of England Decision, Analysts Disagree on Whether Further Advances are Possible

- GBP/USD rallies to highest level since early March
- Bank of England provides fresh impetus
- Can go higher says LMAX Exchange analyst
- But others warn of a decline, saying August-December are poor months for GBP

• Spot GBP/USD rate at time of writing: 1.3152
• Bank transfer rates (indicative guide): 1.2884
• FX specialist rates (indicative guide): 1.3034
• More on FX specialist rates, here

The British Pound has rallied to a fresh 5-month high against the U.S. Dollar after the Bank of England's August update, which proved to be of more interest than markets had been expecting, but analysts are divided over whether further gains are likely or whether the Pound will succumb to traditional year-end weakness.

The Bank opted to keep interest rates and quantitative easing unchanged, but Sterling liked a couple of developments: 1) the unanimous vote to keep settings unchanged showed there is no rush to change policy 2) cutting interest rates to 0% or below is not high on the Bank's agenda at present and 3) their assessment of recent economic performance and expectations for future performance were slightly more optimistic than expected.

"Sterling has initially spiked higher in the wake of the BoE announcement possibly helped by a lack of indication that a move to negative interest rates is imminent," says Rhys Herbert, Senior Economist at Lloyds Bank.

The Pound-to-Dollar exchange rate rallied from a daily low at 1.3121 to reach a high at 1.3183, its best exchange rate since March 09 for those looking to buy dollars, and one analyst says further advances are possible.

"The market has rebounded sharply, after collapsing to a +30 year low below 1.1500. This supports the longer-term constructive outlook, with a major bottom sought out ahead of the start to a big run to the topside back through 1.3000 and towards the 2019 high at 1.3515. Look for the pair to hold up ahead of 1.2500 into setbacks," says Joel Kruger, analyst at LMAX Exchange.

"The initial market assessment is that sterling likes the Bank of England update. Seeing that “other tools are available” aside from negative interest rates is a boost. The chart of Cable shows that the market has begun to drive higher again," says Richard Perry, an analyst at Hantec Markets. "Momentum indicators are swinging higher once more in still strongly positive configuration. A decisive closing breakout above 1.3200 would be the next big step forward for Cable."

The Bank's programme of quantitative easing - that was raised to £745BN in June - will likely be spent by the end of the year and the question for markets is whether the Bank adds to its package in coming months; an outcome the market was on balance expecting to be signalled today.

However, no further signals of a potential extension of the envelope be forthcoming would be positive for Sterling as the general rule of thumb is that further quantitative easing is negative for Sterling valuations.

Weighing on the Pound of late has been the dramatic decline in government bond yields which in some cases have fallen below zero, driven by the Bank's quantitative easing programme.

The relatively fast decline in UK yields relative to other countries poses a disincentive for international investors to channel their capital into the UK, thereby depriving Sterling of a source of support.

However, should this trend of falling yields ultimately end as the Bank eases back on quantitative easing, we would imagine the Pound would once more start finding support from this channel.

"The BoE left monetary policy unchanged this morning. It said that it expected asset purchases to finish around late 2020 but stands ready to adjust policy to meet its remit and will not tighten policy until inflation is sustainably moving to target," says Robin Wilkin, a cross asset strategist at Lloyds Bank.

Despite the Pound's recent rally against the Dollar, Wilkin warns that further gains cannot be assured as August is traditionally a poor month for Sterling.

"Prices are now back testing the 1.3200 region," says Wilkin. "We are therefore again wary at these levels due to ending cycle patterns, a strong bear seasonal pattern for GBP in August. A decline through 1.3090 and then 1.3000 would suggest that broader correction is underway, with 1.2850-1.2650 the main trend support region below."

"Heading into August, we think the rest of 2020 is a harbinger of further weakness to come: August-December historically contain four negative months for GBP performance," says Kamal Sharma, analyst at Bank of America Merrill Lynch, who recently slashed their Pound Sterling forecasts.

"Heading into August, we think the rest of 2020 is a harbinger of further weakness to come," says Sharma, who says one source of weakness will be seasonality as his research shows the August-December period is historically a negative period for Sterling performance.

Bank of America Merrill Lynch see headwinds ahead for Sterling as they expect the Bank of England to ultimately consider negative interest rates more seriously while the ending of the Brexit transition period will result in a skinny trade deal, or no deal at all: both poor outcomes for Sterling.

"The fortunes of the pound will increasingly be driven by the monetary policy stance, the ability of the economy to rebound from the global pandemic, and Brexit negotiations, which are effectively stuck in the mud," says Sharma.

Above: The average monthly performance of the Pound measured on a trade weighted basis since 2004.