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  • Pound Sterling recovery faded as investors hope that Fed-BoE policy divergence will neutralize this month.
  • United Kingdom’s housing sector and factory activities are under pressure due to higher interest rates.
  • BoE’s Broadbent warned that interest rates will remain higher for a longer period.

The Pound Sterling (GBP) recovery faltered on Tuesday despite hopes that an interest rate hike of 25 basis points (bps) by the Bank of England (BoE) at its September monetary policy meeting will neutralize the Federal Reserve-BoE divergence. The revival move in the GBP/USD pair faded as further policy tightening by the BoE will dampen the economic outlook.

The consequences of restrictive monetary policy by the United Kingdom’s central bank have widened their scope to housing and the manufacturing sector. Firms are underutilizing their entire production capacity as forward demand seems poor due to rising prices. While nuclear families have postponed their home-buying plans to avoid higher installment obligations. UK inflationary pressures continue to remain persistent despite soft fuel and energy prices.

Daily Digest Market Movers: Pound Sterling drops as market mood turns cautious

  • Pound Sterling falls back due to the widening consequences of elevated inflationary pressures.
  • UK currency drops swiftly despite hopes that the Fed-BoE policy divergence will neutralize this month.
  • Investors are hoping that the Fed will keep its interest rates steady at 5.25-5.50% while the BoE is expected to raise interest rates consecutively for the 15th time. Investors are projecting a 25 basis point (bps) interest rate hike, which will push rates to 5.50%.
  • Strength in the Pound Sterling is hollow as backed by expectations of neutralized Fed-BoE policy divergence. Sterling bulls could lose their strength if the consequences of restrictive monetary policy start multiplying.
  • BoE Deputy Governor Ben Broadbent warned that interest rates will remain higher for a longer period. He further added that inflation will not fade as quickly as it emerged despite soft energy prices.
  • The UK’s housing sector, factory activities, and hiring momentum are slowing significantly due to the historically aggressive rate-tightening cycle by the BoE.
  • Home sellers have lowered prices as buyers postponed their residential investment plans to avoid higher installment obligations.
  • Meanwhile, UK firms continue operating at lower capacity due to a bleak demand outlook. The potential risk of corporate default rises due to contracting debt-service coverage ability.
  • Also, firms have slowed down their recruitment processes as higher interest rates have threatened economic prospects. However, the wage growth is extremely strong, which indicates that firms are favoring talent retention rather than fresh acquisitions.
  • UK PM Rishi Sunak opens for a face-to-face meeting with Chinese leader XI Jinping at the G20 summit to improve diplomatic relations with China. However, XI Jinping has not confirmed his arrival.
  • The US Dollar Index attempts a recovery but remains constrained as investors await the Employment Change data from ADP That data will be published on Wednesday at 12:15 GMT. As per expectations, the US labor market is expected to witness the fresh addition of 195K new jobs in August vs. former additions of 324K.
  • The impact of the August labor market data will be higher as Fed Chair Jerome Powell confirmed in his commentary at the Jackson Hole Symposium that the central bank will remain data-dependent for further policy action.
  • On Tuesday, investors will focus on JOLTS Job Openings data for July, which will provide cues about talent demand by firms. The economic data is seen higher at 9.793M vs. the former release of 9.582M.
  • Later this week, the focus will be on official labor market data and ISM Manufacturing PMI for August, which will provide a base for September’s monetary policy.

Technical Analysis: Pound Sterling drops swiftly below 1.2600

Pound Sterling faces an intense sell-off near 1.2630 after a recovery move from 1.2550 as the market mood dampens. The recovery move in the Pound Sterling was not backed by any strong economic trigger, therefore, the move faded now. The 20 and 50-day Exponential Moving Averages (EMAs) have delivered a bearish crossover, which indicates that the overall trend is bearish. The Cable is expected to find support near the 200-day EMA, which trades around 1.2483.

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.

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