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July 18, 2017

Trading the Cable: Market Insights

The GBP/USD currency pair was trading at 1.3029, down 0.18%, or $0.0024 on Monday, July 18, 2017. The GBP is currently one of the more volatile currencies given that speculators are waiting on the Bank of England MPC (Monetary Policy Committee) members’ opinions vis-à-vis interest rate hikes.

A month ago, (June 15, 2017), the Bank of England MPC met and decided by a margin of 5:3 not to raise interest rates. The current bank rate in the United Kingdom is 0.25%. Bank of England governor, Mark Carney maintained the current interest rate, amid concerns that the UK economy was not quite ready for a rate tightening. Interest rate hikes can nip inflationary concerns in the bud (recall that the recent UK inflation data reported a 2.9% growth), but they also make credit more expensive. UK households are increasingly indebted given the contraction in economic growth in the UK. Real wages are also declining, while prices are rising.

For these and other reasons, the BOE is reluctant to hike interest rates at this juncture. The MPC decided to maintain corporate bond purchases at £10 billion, with government bond purchases at £435 billion. The central bank anticipates that inflation could exceed 3% within months, and that would place additional pressures on the UK economy.

How is the GBP performing?

There are several factors weighing heavily on the performance of the GBP, sending it lower against its rivals. Recently, the deputy governor of the Bank of England, Ben Broadbent announced that any severing of ties between the European Union and the United Kingdom would adversely affect the domestic economy. He also failed to address interest rates in his speech. A leading analyst from Trade-24, Charles McKellen believes that the BOE is going to be slow to increase the bank rate. In June, there were 3 hawks and 5 doves who voted to maintain interest rates at their current level. While this is an encouraging sign for GBP bulls, it is not ironclad.

One of the most important changes to take place is the departure of hawk Kristen Forbes. There is no guarantee that her replacement will adopt a similar hawkish tone in terms of interest rates. BOE governor Mark Carney, and Andy Haldane have both echoed hawkish sentiment recently, but their voting record does not display as much.

They are more likely to consider the broad performance of the UK economy before they switch to a hawkish position with monetary policy. It is somewhat concerning to currency traders and speculators that the deputy governor of the BOE made such deliberate statements about the UK’s relationship with the EU. His comments mirror sentiment about the impact of a hard Brexit on the UK economy.

Pound Plunges After Broadbent Vents

According to Broadbent, UK trade is beneficial to all parties in the equation, but he has not yet expressed his views on interest rates. Traders wasted no time pouncing on this news and shorted the sterling en masse. Many in the currency markets were hoping that the central bank would give some indication of rate tightening.

The GBP/USD pair dropped as low as 1.2887 after the speech. Broadbent’s statement reads as follows: “… The government must protect the city in Brexit negotiations and keep EU trade links open if it is to safeguard growth and maintain UK living standards…’ Bullish sentiment for the GBP could be bolstered by any indication that the Bank of England views the UK economy positively. With Brexit concerns, declining real wages, and rising inflation, there is little to be excited about.

Heading into the final stretch of July, the GBP is holding above 1.30 and looks likely to remain a bullish short-term prospect, especially since weak US economic data (retail sales and inflation) are suppressing the greenback in currency markets.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Item Reviewed: Trading the Cable: Market Insights Rating: 5 Reviewed By: EconMatters