The shake-up in the markets this week has changed a lot of the fundamentals of major currencies. The UK is no exception. Before last weekend, markets were tentatively pricing in one more rate hike from the BOE. Now they are moving towards expecting two, with some even suggesting that the BOE will cut back-to-back.
Of course, Cable Trends are also affected by what is going on across the Atlantic. But, unlike the Euro, where markets had already priced in economic underperformance, the UK had recently reported a strong Q2 growth rate. PMIs were in expansion. This gave the pound more of a downside.
Re-configuring the Fundamentals
The perception before last week’s US NFP data was that the US economy would cruise ahead, while the UK would largely struggle to keep up. That would mean the Fed would likely keep rates higher than the BOE, since it could afford to do so. But now many traders worry that the Fed might have waited too long to start easing. This creates the potential of the Fed cutting rates more aggressively in the near term.
The UK hasn’t experienced a sudden uptick in unemployment, nor have key recession indicators been triggered recently. But, given the importance of finance and trade within the UK economy, it could see its growth pulled down by other major countries in the world. And the BOE has interest rates just off the highest they’ve been in 16 years. Which means the BOE has a similar amount of downward room to ease as the Fed if the situation calls for it. And with the UK economy under-performing relative to the US, that means the BOE ultimately could be more aggressive in cutting than its American counterpart. Hence, the weaker pound with respect to the greenback.
Where Do We Go Now?
Now that the markets have had about a week to calm down, some data has come out to suggest the panic was a bit overwrought. Weekly jobless claims in the US showed an improvement. There have been no major liquidity issues. A correction in the stock market in summer is a common occurrence.
So, if traders get convinced again that the economy is doing well, then risk appetite should reassert itself. The difference is that the projection for more easing will likely stay in place, leaving the pound a bit weaker against the dollar than it was before.
There Are Other Issues
While the markets focus on economic figures, the civil unrest across the country doesn’t make the case for a resilient economy. The UK relies on tourism, and the chaotic scenes could sap interest in visits to the Island.
But more relevant is the new Chancellor, Rachel Reeves, pushing for increased spending and taxes, somewhat contrary to expectations developed during the campaign. She says she wants higher taxes in the new Budget, which could sap investor interest in the UK, weighing further on the pound. Unless next week’s data barrage provides a substantial reason to become more optimistic about the future of the British economy, Cable Trends suggest the pound could end up being generally weaker through the coming easing cycle.
