Pound Under Fresh Pressure After U.S. Fed Greenlights Bank of England Cuts

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Pound Sterling has come under notable selling pressure in the run-up to the Bank of England's decision, with the market increasingly convinced a rate cut will be delivered.

Odds of a Bank of England cut grew overnight after the U.S. Federal Reserves committed to cut interest rates in September. The falling Pound suggests developments across the Atlantic are impacting the UK.

Fed policy developments have significant implications for the Bank of England as UK policymakers would prefer to cut rates under the cover of cuts at the world's most important central bank in order to minimise potential market reactions.

This explains why market-implied odds of a Bank of England rate have steadily risen alongside rising odds of a Federal Reserve rate cut.

The Pound to Dollar exchange rate is down three-quarters of a per cent at 1.2763, the Pound to Euro exchange rate is down a third of a per cent at 1.1837.

"A reduction in our policy rate could be on the table as soon as the next meeting in September," said Federal Reserve Chair Jerome Powell at Wednesday's policy update. 

"With these words, Powell clearly opened the door to a cut in the very near term. The September cut looks like a done deal – and markets are fully priced for that outcome," says Evelyne Gomez-Liechti, Rates Strategist at Mizuho Bank.

Powell said substantial progress had been made with regard to the Fed’s dual mandate of price stability and maximum employment.

"The Fed no longer considers the labour market to be a source of inflationary pressure and is watching closely for signs of further softening," says Luca Cazzulani, Head of Strategy Research at UniCredit.

Above: GBP/USD at hourly intervals, showing a sharp drop over the past 60 minutes as investors prepare for an imminent UK rate cut. Track GBP/USD with your custom alerts; find out more here

The statement said the central bank was "attentive to the risks to both sides of its dual mandate." This means the Fed thinks it can cut interest rates before inflation falls to the 2.0% target because it thinks holding rates at current levels risks raising unemployment.

Heading into today's Bank of England decision, currency strategists say the Pound is faced with a lose-lose outcome and should fall no matter what happens. "Sterling might weaken against both the US dollar and the euro if the BoE were to cut the bank rate today (the implied probability of a 25bp cut is roughly 60% at present)," says Roberto Mialich, FX Strategist at UniCredit Bank.

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But, a hold will also result in weakness, he says. "A steady outcome is unlikely to offer sterling much support, as markets are already positioned for the kick-off of the easing cycle from September in the UK, with 50bp of easing already priced in by December."

The risk for the Pound is that Andrew Bailey and his colleagues are on the cusp of an aggressive interest rate cutting cycle. If today's guidance confirms this, the selling of the Pound can continue.

"Today, we’ll find out how committed the MPC is to firmly embed low UK inflation. If it is, MPC should hold rates & not heed siren calls for rate cuts to feed the nation’s addiction to low interest rates. A cut today would seriously question the Bank’s anti-inflation credibility," says economist and former Bank of England MPC member Andrew Sentance.

Above: The markets see a deeper path of rate cuts than was the case back in April. Image courtesy of Goldman Sachs.

Money market pricing, gleaned from the Overnight Index Swap market, shows that the probability of a hike is now over 60%.

This is up from 40% earlier in the month when markets judged strong services inflation figures would mean the Bank would have to wait until September before cutting.

The rise in odds for an August 01 cut has correlated with a steady fall in the value of the Pound from recent highs against both the Euro and Dollar.

Should the Bank proceed with a cut, further Pound Sterling weakness as the gap between reality and expectations closes fully. "A cut could thus be seen as a slightly more dovish outcome than currently expected by the markets and thus weigh on the GBP," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The risk is that the Bank delivers a cut and says it is ready to cut further. This is the 'dovish' outcome that can result in the biggest hit to GBP value.

However, currency strategists at Barclays think the downside to the Pound will be limited. "A hawkish cut by the MPC is an opportunity for the pound."

A 'hawkish' cut would involve the Bank cutting interest rates but warning it is not committed to further hikes.

"Rate differentials should not be much affected by the reallocation of cuts across the cycle, implying limited damage for the pound. Instead, demand resilience and a willingness to re-engage with the EU are far bigger positive influences for the pound, in our view, and we look to re-engage on the long side on any further weakness," says Barclays.