Finance

Pound Sterling sets for a bumpy ride as BoE’s aggressive policy dampens economy

07/25/2023
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  • Pound Sterling tests the previous week’s low as UK’s preliminary S&P Global PMI remained downbeat.
  • United Kingdom’s factory activity registers 12th straight contraction as the BoE has raised interest rates aggressively.
  • The economic outlook doesn’t look promising as more interest rates by the UK central bank are in the pipeline.

The Pound Sterling (GBP) surrenders its entire gains posted on Friday as the United Kingdom’s preliminary S&P Global PMI data for July came in below expectations. The GBP/USD pair drops as contracting factory activity and a bleak service sector builds pressure on the Pound Sterling. Britain’s economic prospects are facing the wrath of elevated inflation and higher interest rates by the Bank of England (BoE).

Firms in the United Kingdom have postponed their current demand for credit to avoid paying higher interest obligations. The country’s economic outlook doesn’t look promising as the UK central bank is expected to increase interest rates further in August. Going forward, employment conditions are expected to face pressure from weakening economic activity.

Daily Digest Market Movers: Pound Sterling loses appeal after weak PMI

  • Pound Sterling faces selling pressure as the United Kingdom’s preliminary PMI data showed that economic activity remains weaker than expected in July.
  • The UK Manufacturing PMI contracted to 45.0, down from the 46.1 expected and the 46.5 registered in June. This signals the 12th straight contraction in the country’s manufacturing sector. A figure below 50.0 is considered a contraction.
  • Britain’s preliminary Services PMI dropped to 51.5 from the consensus and the former release of 53.0 and 53.7, respectively.
  • Economic activity appears to be facing the wrath of restrictive monetary policy by the Bank of England.
  • Investors look mixed about the scale at which the Bank of England will raise interest rates in August.
  • Inflation pressures in the United Kingdom look persistent even as the Consumer Price Index (CPI) softened in June as consumer spending remains resilient.
  • Monthly Retail Sales expanded at a pace of 0.7% in June, more than the 0.2% increase expected and accelerating from the 0.1% seen in May. On an annual basis, consumer spending contracted 1.0%, softer than the estimates of a 1.5% decline and the prior release of a 2.3% decrease.
  • In spite of a decline in inflation, consumer spending picks momentum as lower gasoline prices provide higher disposable income to households.
  • Sales at food retailers were weak, possibly because expenditure on dining out was higher due to an extra public holiday to mark King Charles’ coronation.
  • Resilient momentum in consumer spending has offset the comfort provided by surprisingly softer inflation data.
  • Expectations of a big rate hike from the BoE in August have made a comeback as upbeat retail demand could propel inflationary pressures again.
  • Soft inflation in June offers relief to BoE policymakers, but the upside risks of elevated core inflation are still solid.
  • The US Dollar Index (DXY) delivers a north-side break after an extended consolidation around 101.00 as investors turn cautious ahead of the Federal Reserve’s (Fed) monetary policy meeting.
  • An interest rate hike of 25 basis points (bps) is anticipated from the Fed, which will push interest rates to the 5.25%-5.50% range.
  • Investors expect interest rates to peak on July 26 and then to remain stable for the rest of the year.
  • Investors will keep an eye on the Fed’s interest-rate guidance. A hawkish guidance might trigger a risk-off mood.
  • United States consumer spending grew at a marginal pace in June due to declining demand for big-ticket items.

Technical Analysis: Pound Sterling eyes more losses towards 1.2800

The Pound Sterling meets stiff resistance below 1.2900 as the market mood has turned cautious. The Cable is expected to test its recent low of 1.2816 recorded on Friday. Earlier, the asset delivered a recovery move after gauging support below the 20-day Exponential Moving Average (EMA). The Cable would find next support near the 50-day EMA around 1.2700 if it continues to decline further. The upside momentum has completely faded, but the long-term trend is still bullish.

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.

Source: https://www.fxstreet.com/news/pound-sterling-bulls-face-wrath-of-higher-interest-rates-downbeat-pmi-data-202307240930