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Sterling dips ahead of central bank rate decision; long bets trimmed

The British pound edged lower on Monday as markets await this week’s Bank of England decision on interest rates, which many analysts see as too close to call.

While weak economic data and dovish comments from BoE policymakers have fuelled speculation that the central bank could cut rates at its Jan. 30 policy meeting, though upbeat economic numbers in recent days have cast doubt over that view.

For instance, Friday’s early readings of the IHS Markit/CIPS UK Purchasing Managers’ Index (PMI) showed that Britain’s vast services sector returned to growth in January for the first time since August while manufacturing woes receded.

In subdued Monday trading, sterling dipped 0.1% to $1.3056, sliding below a more than two-week high touched briefly on Friday at $1.3180.

Against the euro, sterling hovered around 84.41 pence, broadly steady on the day.

“This (BoE) meeting follows a run of fairly weak economic data over the last few weeks but with last week’s strong employment data and better than expected flash PMIs confusing the picture,” said Deutsche Bank strategist Jim Reid.

“Our economists have expected a cut for a good couple of months now, but markets are closer to 50:50.”

Analysts noted that market positioning data released on Friday by the U.S. Commodity Futures Trading Commission suggests that, though speculators have slightly reduced net longs in sterling, they maintain an overall long position.

But market watchers believe the drop in positioning is not reflective of changing interest rate expectations. Market expectations of a rate cut dropped to 59% on Monday, compared with more than 70% a week earlier.

“Last week’s relatively marginal correction in positioning has done little to dent the view that speculative investors remain broadly sceptical about the possibility of a cut,” ING strategists said in a note.

Those bets on further gains in the British currency could be vulnerable as Thursday’s BoE meeting draws nearer, putting downward pressure on the pound, they said.

Elsewhere, the BBC reported Irish Prime Minister Leo Varadkar as saying the European Union will have the upper hand in post-Brexit trade talks with Britain and questioned Prime Minister Boris Johnson’s timetable for a deal to be truck by the end of the year.

Britain will formally leave the European Union on Friday.

Reporting by Dhara Ranasinghe

Source: UK Reuters

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Two years on: how Brexit has affected the UK economy

The UK economy was supposed to plunge into recession soon after the vote to leave the EU, but the majority of forecasters were wrong.

Consumer confidence remained positive, encouraging increased spending, despite a slowdown in almost every other sector of the economy. As household consumption is a large contributor to GDP growth, it more than offset weakness elsewhere, painting a picture of success for those backing Brexit.

However, the growth in consumption to its fastest rate since 2005 was totally unsustainable. As the pound plunged after the vote, the cost of imports rose for manufacturers and retailers. This did not deter shoppers at first; indeed, households reduced their savings rate to record low levels in order to fund the post-Brexit splurge.

How inflation has affected household and business spending

Eventually, inflation caught up and households were forced to cut back, causing the economy to slow sharply over 2017. The UK went from being the fastest growing economy in the G7 to the slowest.

Businesses had started to postpone and cut investment projects as far back as 2015, well before the referendum result was known. Since then, business investment has fallen further, only to recover a little in recent months. It grew by just 2.4% in 2017, half the rate averaged between 2011 and 2015. Moreover, the initial surge in foreign direct investment (FDI) after the fall in the pound has now ended. There was an 82% fall in inward FDI in Q4 2017 compared to Q4 2016. Instead, pessimism has taken hold with planning focused on the worst-possible outcome. Some companies have even started to relocate staff, for fear of facing restrictions on their ability to do businesses.

Looking ahead, UK economic growth is likely to be sluggish at around 1.4% in 2018. With inflation forecast to average 2.6%, the UK will feel like a stagflationary environment for some time. As for 2019, the outlook is very uncertain. We assume a transition period will be agreed that preserves the status quo of the single market and customs union membership, but this is unlikely to help growth recover much.

When will the Bank increase rates?

Meanwhile, the Bank of England (BoE) is closely monitoring Brexit events and the reaction in the economy. After aborting a rate hike in May, the consensus has shifted dramatically away from a rise in the near term, to one possibly by the end of the year (63% chance priced by markets).

The next BoE Inflation Report is due in August, which provides the Bank another opportunity to consider its policy stance, but given recent weakness in both UK and overseas data, the bank rate is likely to remain on hold.

We forecast the BoE to hike once more in 2018 (November), and two more times in 2019 after the 29 March Brexit deadline.

Source: City A.M.