BoE: Easing package to reignite sterling’s weakening trend - TDS

Research Team at TDS, suggests that the BoE’s easing package is very likely to reignite sterling’s weakening trend, in our view.

Key Quotes

“Our primary concern heading into today’s announcement was that policymakers will disappoint and fall short of expectations they would confront the challenges posed by Brexit with a direct and pre-emptive approach. That is not the case, however, and the combination of rate cuts, asset purchases, and credit enhancements sends a clear signal to currency markets. The sterling weakness that we expect will complement the BoE’s policy initiatives in supporting the UK economy.

That said, sterling’s fundamental outlook remains considerably bearish. The sharp move lower in UK interest rates across the curve significantly worsens rate differentials to the USD. Current levels suggest that fair value on this basis stands close to the 1.25 mark, our existing end-Q3 forecast. The strong hints that further easing may be in the pipeline is likely to keep this differential under pressure going forward and unlikely to recover meaningfully any time soon. While Caney has taken the prospect of negative interest rates off the table, we are less concerned that this is likely to provide sterling with a significant degree of support.

The post-announcement break below trendline support around 1.3180 in GBPUSD provides technical support for our expectations of renewed weakness there. This puts our immediate focus on the 26 July low at 1.3058 ahead of the immediate post-referendum trough at 1.2798 as the primary attractors to the downside.

Friday’s US employment report is an obvious event risk in the very short-term, but we think any setback is likely to remain temporary at this stage. That said, positioning remains a more notable concern as net shorts are elevated. We do not yet think these have reached the point where they represent a major constraint, but it will be worth monitoring closely for signs that investor exposures have grown too large.

On a longer-term basis, the UK economy – and its currency - continues to face significant headwinds. The combination of a dovish central bank, slowing growth, and rising inflation pressures makes for a toxic cocktail for the pound. In addition, the uncertainty surrounding the Brexit process means sterling’s risk premium will remain elevated.

At the same time, the UK faces considerable risks from its balance of payments. The greater reliance on portfolio inflows to finance the yawning current account deficit remains a structural risk for the GBP. This keeps us focused on our year-end forecast of 1.20 as the centre of gravity for remainder of 2016.”