British Pound holds losses below 1.3400 as PM Burnam stokes fiscal worries
- GBP/USD consolidates losses below 1.3400 after its reversal from 1.3558 highs last week.
- A mix of softer inflationary pressures and renewed fiscal worries is hammering the Pound.
- FX analysts from major commercial banks see the Pound depreciating further in the near-term.
The British Pound (GBP) consolidates losses below 1.3400 against the US Dollar (USD) on Thursday, on track for a 0.6% weekly decline, following a reversal from 1.3558 highs last week. The soft inflation figures released on Wednesday, coupled with growing concerns about Prime Minister Andrew Burnham’s spending plans, have sent the Pound lower across the board this week.
Data released on Tuesday revealed that UK consumer inflation eased to a 2.6% year-on-year pace, its lowest growth pace since March last year, with producer prices slowing down well beyond expectations in June. These figures provide the Bank of England (BoE) with more time to assess the impact of the volatile energy prices on the UK economy and push back hopes of any rate hikes.
UK fiscal risks cloud outlook
Beyond that, the first policy announcements by PM Burnham have left investors wondering how he will fund his spending pledges, which has brought fiscal worries back to the table. Strategists at Brown Brothers Harriman warn that “the prospect of higher spending and borrowing under incoming Prime Minister Andy Burnham risks worsening UK fiscal credibility and is a drag on GBP,” reinforcing a cautious stance on the Pound.
Against this background, FX experts from some of the world's main commercial banks see the Pound trading lower in the coming weeks. Analysts at UOB Group maintain a cautious medium-term stance on GBP, reiterating that “downward momentum is increasing rapidly, and if GBP closes below 1.3340, it is likely to decline further to 1.3300.”
They note that this bearish bias was first highlighted “following the sharp decline in GBP two days ago,” when they judged that “the likelihood of GBP closing below 1.3340 will remain intact as long as the ‘strong resistance’ level, now at 1.3455, is not breached.” While UOB says it “continue[s] to hold the same view,” the bank has now adjusted that technical marker, “revising the ‘strong resistance’ level to 1.3435,” thereby lowering the threshold that would invalidate the current downside scenario.
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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