- Pound Sterling recovery falters as the risk-off profile eases, while broader bias is still weak.
- The UK economy shrank in July due to a sheer decline in service sector output.
- Investors await the inflation data for August, which will be released next week.
The Pound Sterling (GBP) recovery fades due to the upside risks of the global economic slowdown. The asset retreats as the broader trend is bearish due to bleak economic fundamentals. The GBP/USD pair could resume the downside journey as the tight interest rate policy by the Bank of England (BoE) has dampened the labor demand outlook and has exposed the economy to a possible recession.
The UK economy shrank in July due to a sheer decline in service sector output as persistent inflation narrowed households’ pockets. Inflation risks are skewed to the upside as wage growth remains strong. The Pound Sterling is expected to deliver a bumpy ride as investors shift focus to the Consumer Price Index (CPI) data for August, which will be released next Wednesday. The inflation data will be followed by the interest rate decision from the BoE, which will be announced next Friday.
Daily Digest Market Movers: Pound Sterling faces selling pressure as market mood dampens
- Pound Sterling fails to sustain above 1.2400 due to the consequences of higher interest rates by the Bank of England amid the battle against stubborn inflation.
- UK labor market slowed down and the economy contracts at a sharp pace in July as firms avoid banking on higher inventories and larger labor forces amid a deteriorating demand environment.
- UK firms focus on cutting input and labor costs to address bulky interest obligations due to rising mortgage costs.
- British job market witnessed a reduction in labor for the second straight month. In July, lay-offs were recorded at 207K, while investors anticipated a retrenchment of 185K.
- UK monthly Gross Domestic Product (GDP) for July shrank by half a percent, contributed to majorly by service output, which dropped by 0.5%.
- 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%. In a similar period, Manufacturing Production contracted by -0.8%, a slower pace than expectations of a 1.0% contraction.
- In spite of a drawdown in the job market and deepening fears of an economic slowdown, higher inflationary pressures are going to force the BoE to raise interest rates further.
- Strong wage growth momentum is the major catalyst behind a persistent inflation outlook. Three months to July Average Earnings excluding bonuses remained in line with estimates and the former figure at 7.8%.
- A Reuters poll showed that the BoE is going to raise interest rates by 25 basis points (bps) to 5.50% in its upcoming monetary decision, which is scheduled for September 21. A minority of BoE policymakers would favor keeping doors open for further policy tightening.
- The uncertainty over the interest rate outlook remains higher as BoE Governor Andrew Bailey conveyed last week that the interest rate peak is near.
- Before September’s monetary policy, investors await the inflation data for August, which will be published on Wednesday.
- Any surprise rise in inflation would dampen the UK’s economic outlook further.
- Meanwhile, the risk appetite of market participants improved nominally as investors shrugged off risks associated with a global economic slowdown. The market mood turned cheerful as China’s Industrial Production and Retail Sales grew at a faster pace in August.
- The US Dollar Index (DXY) witnessed some profit-booking after a refreshing six-month high at 105.44. The upside bias is still upbeat as strong monthly Retail Sales data for August propelled consumer inflation expectations.
- Consumer spending expanded at a higher pace of 0.6% vs. estimates of 0.2% and July’s reading of 0.5%, driven by higher gasoline prices.
- Meanwhile, weekly Jobless Claims remained higher than the prior week’s figures after declining straight for five weeks. Individuals claiming jobless benefits for the first time rose by 220K, while investors anticipated higher jobless claims at 225K. In the previous week, jobless benefits were recorded at 216K.
Technical Analysis: Pound Sterling seeks support near 1.2400
Pound Sterling falls back after failing to sustain above the cushion of 1.2400 as the risk appetite theme eases. The recovery move in the Cable that was backed by a sell-off in the US Dollar faltered due to an absence of supportive fundamentals. Investors used the pullback move as a selling opportunity. The asset seems settled below the 200-day Exponential Moving Average (EMA), which trades around 1.2480.
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.