As the currency with one of (if not the) most sensitive risk profiles in the G10 currency space, the fall in GBP in recent sessions has been particularly severe. The shift in sentiment is highly visible against a rising US Dollar, with the Pound having suffered as markets are increasingly concerned about the potential impact that the European energy (and UK fuel) challenges could have upon UK growth. The market was slow to react to last week’s monetary policy decision at the Bank of England. It was clear that the Bank was already seeing growth prospects slowing in the UK with the rate of economic rebound slowing amongst consumers. The narrative of transitory inflation was also toned down, with the bank uttering strong words on inflation expectations amongst the public. There was one other thing that has rattled and likely exaggerated Sterling’s decline:
When the 2008 financial crisis unfolded, central bank’s balance sheets went from around 0 to the low trillions of Dollars seemingly overnight. Since then, through European Sovereign Debt Crisis, UK double-dip recession and US moderate growth, these balance sheets have remained a feature of the global economy. Whilst QE was nothing new, the size of central bank intervention in markets was unprecedented. Central banks therefore had to guide consumers and industry alike through what it planned to do next. One seemingly golden rule that came out of this forward guidance was that in almost every nation, a reduction in the bank’s balance sheet had to precede a change in the bank’s core rate. This means that markets knew that so long as the central banks left their asset purchase/QE/money printing operations on, they didn’t have too much to worry about regarding a change in underlying benchmark interest rates.
Not anymore… it seems. Given the concern that Governor Bailey and the Monetary Policy Committee at the BoE seem to have surrounding increasingly persistent inflation and slowing economic expansion, they seem to be voluntarily breaking this link. For fear of enduring a condition of stagflation, the Governor announced that a rate rise could come sooner than tapering. This led markets to price in a likely rate hike before year end. Of course, GBP could benefit from the higher rate of interest and faster than anticipated return towards normalisation. However, with markets distracted by queues at the pumps and astronomical gas prices ahead of winter, the fear is whether the consumer can endure these price hikes and deliver the UK admirable growth rates. With a break of key support in recent sessions, the market will also have technical factors to consider when establishing the value of GBP.
Discussion and Analysis by Charles Porter