- Pound Sterling advances to 1.2200 as the risk appetite of the market participants improved.
- The UK economy is likely to continue to face the wrath of high inflation and slowing demand.
- High inflation and slowing labor demand could trigger stagflation risks in the UK economy.
The Pound Sterling (GBP) recovered to near 1.2200 after discovering a cushion near 1.2100 as a mild correction in the US Dollar improved the appeal for risk-sensitive assets. Earlier, the GBP/USD pair was on the backfoot as investors were dumping risk-perceived assets due to a cautious market mood. The GBP/USD outlook remains vulnerable as risks of a recession in the United Kingdom have increased due to vulnerable economic prospects. The UK’s Manufacturing and Services PMI, which gauge the health of both sectors, have fallen into contraction territory, while strong labor demand appears to be fading.
The UK economy is seen losing strength amid uncertainty over the interest rate outlook ahead of the general elections. UK Prime Minister Rishi Sunak promised to halve inflation to around 5.3% by year-end, but the pause announced by BoE policymakers signals that the Prime Minister may fail to keep the word. For further action, investors will focus on the final S&P Global Manufacturing and Services PMI, which will be released next week.
Daily Digest Market Movers: Pound Sterling capitalizes on cheerful market mood
- Pound Sterling recovers posting a fresh six-month low near 1.2110 as the risk-aversion theme starts fading away while the broader bias is still bearish.
- The broader appeal for risk-perceived assets remains weak as rising oil prices and high inflation are deepening risks of a global slowdown.
- The GBP/USD pair remained under intense pressure as the UK economy is facing the headwinds of a stubborn inflation outlook and deepening recession risks.
- Unlike the US economy, the UK is struggling to cope with the consequences of higher interest rates.
- The Bank of England surprisingly paused its historically aggressive policy-tightening spell after raising interest rates 14 times in a row.
- The sudden interest rate pause conveyed that the UK economy is going through tough times. Before the pause, traders were expecting the interest rate peak at 5.75% as inflation in the UK is the highest among G7 economies.
- The BoE’s pause has elevated upside risks to inflation, further dampening the UK’s economic prospects. Labor demand has recently softened, but wage growth remains strong and this may keep inflation persistently high.
- Investors remain worried whether UK PM Rishi Sunak will fulfill his promise of halving inflation to around 5.3% by the year-end.
- Fears of a slowdown in the UK economy have deepened as the Services PMI shifted to contraction territory. Middle-class families have cut spending on services as high inflation squeezes real income.
- While the BoE’s interest rate pause highlighted the poor economic outlook, there is increasing evidence that the situation of the real-estate sector is improving as home-buyers see scope for lower mortgage rates ahead. UK’s property website Zoopla said the volume of inquiries for new homes rose by 12% over the past four weeks.
- Meanwhile, there are increasing risks of piling debt on the UK economy. Britain’s Institute for Fiscal Studies (IFS) estimated on Thursday that there was a 90% chance that public borrowing in four years’ time would be higher than the government’s budget watchdog has forecast, Reuters reports.
- The US Dollar continues to capitalize on the risk-off market mood, a resilient US economy, and the hawkish stance of Federal Reserve (Fed) policymakers on interest rates.
- The US Dollar Index (DXY) is inches away from an 11-month high of around 107.00. The asset is expected to continue its four-day winning spell as investors shift focus to the Fed’s preferred inflation gauge.
- On Wednesday, the US Dollar strengthened further after the release of surprisingly positive US Durable Goods Orders data. Orders surprisingly rose by 0.2% against expectations of a 0.5% decline. In July, Orders contracted by a sharp 5.6%.
Technical Analysis: Pound Sterling revives to near 1.2200
Pound Sterling discovers buying interest near 1.2100 as the risk appetite of the market participants improves. The GBP/USD pair rebounds after refreshing a six-month low near the round-level support of 1.2100. The downside spell in the GBP/USD pair could continue to the psychological support of 1.2000 as the 200-day Exponential Moving Average (EMA) starts declining. Momentum indicators continue to trade in the bearish territory, warranting more downside for the pair.
BoE FAQs
The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).
When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.
In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.
Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.