Pound Sterling falls back as higher interest rates falter economic recovery
- Pound Sterling’s buying interest fades amid a cautious market mood.
- The United Kingdom’s economic recovery falters as firms face the burden of higher interest rates.
- The BoE cannot pause the rate-hiking spell as UK inflation heavily diverges from the desired rate.
The Pound Sterling (GBP) struggles to extend recovery and drops sharply amid bleak economic prospects propelled by higher inflation and aggressive monetary policy by the Bank of England (BoE). The GBP/USD pair picks demand as the market mood has turned bullish amid hopes that interest rates by global central banks will peak sooner than expected.
United Kingdom’s preliminary factory activity faltered in July as firms postponed the demand for credit to avoid higher interest obligations. Apart from costly borrowing rates, demand for big-ticket items has slowed as many households are struggling to buy essentials. Meanwhile, housing demand is also facing increasing pressure as individuals are restricting themselves from borrowing money to avoid higher mortgage rates.
Daily Digest Market Movers: Pound Sterling drops as market mood turns cautious
- Pound Sterling drops as the economic outlook has dampened due to higher interest rates by the Bank of England.
- S&P Global reported on Monday that United Kingdom’s factory activity contracted to 45.0 in early July, missing the 46.1 expected and below the 46.5 seen in June, recording a 12th straight contraction in the manufacturing sector. A PMI figure below 50.0 suggests contraction.
- UK’s preliminary Services PMI dropped to 51.5 from the consensus and the prior release of 53.0 and 53.7, respectively.
- July preliminary PMIs were the weakest since January, adding to evidence of the pinch of high inflation and higher interest rates by the Bank of England.
- A sluggish economic outlook has reinforced expectations of a recession in the British economy.
- Uncertainty about UK inflation still persists as resilient consumer spending could offset the recent slowdown in inflation.
- Aggressive BoE’s policy-tightening is building pressure on first-time home buyers. UK homebuilders have cut down on purchasing land and construction activities, Reuters reported.
- To offer support to the middle class that pays high rents, UK Prime Minister Rishi Sunak promised to build one million homes by the next election.
- However, the pressure of higher mortgage rates is likely to stay for longer as the UK central bank is preparing for fresh rate hikes to tame sticky inflation.
- June’s softening price pressures might offer some time to BoE policymakers to reshape the roadmap of bringing inflation down, but a small interest-rate increase in August cannot be ruled out.
- The US Dollar Index (DXY) comes under pressure as investors are certain about an interest rate hike of 25 basis points (bps) by the Federal Reserve (Fed) on July 26 to the 5.25%-5.50% range.
- Investors focus on the interest-rate guidance from Fed Chair Jerome Powell as Fed officials have reiterated the need for one more interest-rate hike in addition to July’s increase.
- Contrary to Fed officials, investors expect that Fed’s 17-month policy tightening cycle will peak on July 26.
- United States preliminary July Manufacturing PMI outperformed expectations but remained below the 50.0 figure that separates contraction. Meanwhile, the Services PMI fell from June’s reading and came in below consensus.
- After the Fed policy meeting, investors will shift their focus toward the second quarter Gross Domestic Product (GDP) data and June’s Durable Goods Orders.
Technical Analysis: Pound Sterling maintains auction above 1.2800
Pound Sterling extends its recovery to near 1.2850 as market sentiment has turned bullish on hopes that the Federal Reserve’s (Fed) interest-rate hike in July will be the last nail in the coffin. The Cable is building a base after declining during more than a week below the 20-day Exponential Moving Average (EMA). More broadly, the asset maintains higher highs and higher lows, indicating strength in the upside bias.
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.