- Pound Sterling attracted significant offers as UK factory activities contracted sharply.
- Lay-offs in the UK labor market, higher wage growth, and weak factory activities elevate troubles for BoE policymakers.
- BoE Breeden warned that risks to inflation are skewed to the upside.
The Pound Sterling (GBP) remained offered on Wednesday as the UK’s Office for National Statistics (ONS) reported that the economy shrank by 0.5% in July and factory activities contracted significantly due to a deteriorating demand outlook. The GBP/USD pair witnessed an intense sell-off as higher interest rates by the Bank of England (BoE) triggered an economic slowdown and firms remain reluctant to full-capacity utilization.
After significant layoffs and weak factory activities in July, it is evident that the UK economy is failing to absorb the burden of restrictive monetary policy. Meanwhile, strong wage momentum has boosted upside risks to inflation and warrants more interest rate hikes from the BoE to contain the highest inflation among G7 economies. Sarah Breeden, who will replace the BoE’s Jon Cunliffe for Deputy Governor in November, also said that risks to inflation are skewed to the upside.
Daily Digest Market Movers: Pound Sterling falls back on dismal outlook
- Pound Sterling dropped vertically as UK factory activities contracted in July, demonstrating repercussions of higher interest rates by the Bank of England.
- UK’s ONS reported that monthly Industrial Production contracted by 0.7%, which was a higher pace than expectations of 0.6%. In June, the economic indicator expanded by 1.8%.
- Monthly Manufacturing Production contracted by 0.8%, while investors anticipated a contraction of 1.0%. In the same period a month ago, the economic data expanded by 2.4%.
- The Gross Domestic Product (GDP) data shrank by 0.5% on a monthly basis vs. an expansion of 0.5% in June. Investors anticipated a contraction of 0.2%.
- Goods Trade Balance remained below the estimates and the prior release, which indicates that traded volume was due to the dismal economic outlook.
- On Tuesday, the labor market report for August indicated that wage growth momentum remained strong while lay-offs exceeded hiring numbers as UK firms remained worried about a deteriorating demand environment.
- UK employers shed 207K jobs in the three months to July, more than the 185K decline forecasted by markets. In the three months to June, the labor market lost 66K payrolls.
- The Unemployment Rate for the quarter ending in July rose to 4.3%, as anticipated by market participants, from the prior reading of 4.2%.
- Average Earnings excluding bonuses in the three months to July landed at 7.8%, in line with estimates and the former release. Wage growth data including bonuses rose to 8.5% against projections and the former release of 8.2%.
- The labor market report accelerated uncertainty over the interest rate outlook as strong wage growth could force BoE policymakers to discuss increasing rates, though bleak labor demand could be a limiting factor for more interest rate hikes.
- Sarah Breeden, who will replace BoE Deputy Governor Jon Cunliffe in November, thinks risks to inflation are skewed to the upside. She forecasted the achievement of price stability in two years.
- For the September monetary policy, investors expect that the BoE will raise interest rates consecutively for the 15th time. An interest rate increase of 25 basis points (bps) is highly anticipated, which will push interest rates to 5.50%.
- The market mood remains cautious as investors await the United States inflation data for August, which will be published at 12:30 GMT.
- Monthly US headline Consumer Price Index (CPI) and the core inflation are seen rising 0.6% and 0.2%, respectively. The headline inflation is going to reflect the impact of the recent rally in oil prices.
- From May, global oil prices have gained as much as 40%, which has boosted gasoline prices and elevated the burden on households by squeezing their real income. This could add to troubles for Federal Reserve (Fed) policymakers and force them to raise interest rates one more time this year.
- The US Dollar demonstrates a volatility compression ahead of the inflation data. The inflation data for August carries higher importance as it would be the last one for the Fed to consider before its September 20 interest rate decision.
Technical Analysis: Pound Sterling refreshes three-month low
Pound Sterling prints a nearly three-month low around 1.2450 as UK economic activities remained vulnerable in July. The Cable faces an intense sell-off and is exposed to more downside. The major trades below the 200-day Exponential Moving Average (EMA) are around 1.2500. The short-term trend is bearish as the 20 and 50-day EMAs are downward-sloping, and momentum oscillators portray strength in the bearish impulse.
What does the Bank of England do and how does it impact the Pound?
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).
How does the Bank of England’s monetary policy influence Sterling?
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.
What is Quantitative Easing (QE) and how does it affect the Pound?
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.
What is Quantitative tightening (QT) and how does it affect the 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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