In the recent Bank of England’s (BOE) Monetary Policy Committee Meeting, members of MPC voted with concerted effort to keep the bank rate unchanged at 0.75%. This led to a deterioration in sterling value and created a new 52-week low of 1.2080 versus the dollar on August 01, 2019. Also, the pound sterling tested a level below 1.21 first time since January 2017.
If we want to throw some light on recent volatility, we would find that the underlying growth has been softening since 2018 to a rate below expected. This is mainly on account of Brexit related uncertainties hovering on the business environment and softening global growth on a net trade basis. The recent data coming from the UK businesses up to mid-of-July reflects that uncertainty over Britain’s future trade relationship with the EU bloc has become more ingrained.
In the Inflation Report, the MPC stated that due to growing uncertainties on the kind of Brexit that would take place, the economy could follow a wide range of directions in the years to come. The apt result of the monetary policy would depend on the combined effects of supply and rates of currency exchange along with Brexit on demand. Also, the MPC’s response to the UK’s withdrawal from the EU bloc could be in either direction, irrespective of the decision whether it’s with deal or no-deal. The committee would decide appropriate policies to maintain inflation within the target of 2%. However, CPI inflation was in line with the BOE’s target of 2.0% for June 2019 and core CPI inflation was at 1.8%.
Global growth appears to have slowed marginally in the second quarter.
Source: Inflation report, BOE
On account of heightened trade tensions, the global growth outlook has been impacted, and UK-weighted global GDP growth appears to have softened marginally to 0.4%, marginally lower than forecasted in May.
Deteriorating global growth, primarily in the manufacturing sector as per the recent data, is primarily reflecting the impact of a trade spat. This has risen over the past year and deteriorated further since May. The United States and China both have imposed higher tariffs on each other.
The MPC committee recognized that that economic outlook of the UK would remain volatile in the wake of a no-deal- Brexit kind of scenario, which will define the new trading relationship of the UK with nations in the EU and also on how financial markets, businesses and households are going respond to this.
The UK’s economy after having grown by 0.5% in the first quarter of 2019, now is widely expected to remain flat in the second quarter of 2019. This implies that underlying growth in the UK economy could soften as compared to the same period of the corresponding year. Despite a strong household consumption-driven growth, jolted business investments have prevailed in the economy.
The Pound Sterling went below 1.21 level first time since May 2017.
In July 2019, the pound depreciated approximately 4.2% against USD, as currency traders worried over the potential hard exit of Britain from the EU bloc. The sharp decline in the Pound could push consumer prices up, and that could be a new problem for the BOE policymakers. The policymakers are already struggling with how to manage an inflating risk of a no-deal divorce of the UK from the EU. But this is just the beginning and things could get worse for the Pound sterling in months to come.
GBP/USD price chart – Source: Thomson Reuters.
In the above chart, on August 01, 2019, the sterling Pound had tested a level below 1.2096 against the US dollar, a level created in May 2017. The pound ended the August 01, 2019 session 0.29% below its previous closing level and registered a 52-week low of 1.2080 against USD. And on a Y-o-Y basis, the Pound has declined approximately 7.36% and on a YTD basis it has gone down by 4.6%.
What does technical indicates for sterling?
Source: Thomson Reuters
The current trend indicates a steep downtrend fall in the currency, as it was trading substantially below its 200-day exponential moving average price, a technical measure that indicates a long-term downtrend. Also, RSI level indicates that Pound has entered a steep oversold zone and in the price chart it clearly shows that the number of times the currency went through an oversold zone is much higher than the number of times it went through an overbought zone in the past one year. This itself is an indication that shows that market participants are largely bearish on the GBP against the basket of major currency. 14-RSI oversold to the overbought ratio in the past one year stood at 1.6x.
Also, from Bollinger Band® standpoint, in the past one year, most of the time the Pound traded near to its lower Bollinger Band®, and since late April 2019, the currency is in a steep downtrend. Recent trends indicate significant volatility and that the downtrend could prevail in the foreseeable future. However, 1.19 is the crucial support for GBP against the Dollar, and breach of that level could drag it down considerably.
BOE’s latest monetary policy impact on the interest rates
Source: Thomson Reuters
Lowering of interest rates reflects investors heightened expectations for a no-deal Brexit or disorderly Brexit. As per the latest survey conducted by media houses, respondent’s expectation for a no-deal Brexit has increased substantially since May, this year. This led them to shift their investment to investment-grade bonds; as a result, yields are reducing. Majority of them believe that economic condition is going to worsen as the prospects of a no-deal Brexit has shot up substantially. A consensus forecast suggests another 2% devaluation of the sterling.
However, increased chances of a no-deal Brexit and its implied effect on the sterling is strengthening the share prices of London Stock Exchange-listed those companies who earn large-part of their revenue from the global markets. Since May 2019, post increased chances of a disorderly Brexit, the FTSE 100 index has risen, and in contrast, the FTSE All-share index has remained broadly unchanged. As most of the FTSE 100 companies earn their revenue in foreign currency, a sterling devaluation could erode their top line.
Meanwhile, Head of BOE Mark Carney in his conference warned that a disorderly exit of Britain from the EU bloc, with no transition, could pull down sterling, and this will increase risk premium on the UK assets and in a scenario like this, interest rate could rise to stabilize sterling against the pool of other major currencies.
He also added that “a disorderly exit could have strange effects on the economy, and it could impact both demand and supply. Also, said that exit without deal doesn’t mechanically mean a rate cut, it could rise also.”
However, CPI inflation is quite in line with the BOE’s threshold limit, and inflation is expected to remain below a 2% target in the near-term, mainly on account of lower energy price. Also, crude prices are expected to be lower, so the contribution of the crude derivative to CPI inflation turns negative. Also, retail gas prices are expected to be lower in the fourth quarter on account of Ofgem energy price gap.
The core inflation which discounts the impact of energy and another volatile item was at 1.8% in June 2019 and broadly forecasted to be flat in the second quarter of 2019.
Therefore, the bottom line is UK economy will continue to be volatile, as chances for a no-deal Brexit has spiked substantially post Mr Boris Johnson took charge as the new Prime Minister. His continuous assertions to take Britain out of the union has risen volatility in sterling, bond yields and in other financial market measures. Also, the current trend indicates that corporate earnings of the UK and EU focused business could report lower sets of numbers in the quarters to come. Also, new business investments would remain muted in the wake of a no-deal Brexit and on the future trade relationship between Britain and EU nations. This will have a substantial impact on the GDP in the third quarter of 2019, as we have already seen a contraction in manufacturing activities in the latest PMI Manufacturing data released. We estimate contraction in the manufacturing activities could be higher than that reported earlier. Also, the rising US-Sino trade dispute would have a considerable impact on global growth. Bond yields could decline further as demands of investment-grade assets could rise amid growing volatility.