This article was written by Arjun Lakhanpal, FX trader and financial market analyst at SAVI Trading.
Sterling has recently come under substantial selling pressure, dropping below the critical 1.3000 support level for the first time in more than a month after dovish remarks from MPC member Ian McCafferty conveying that more QE may be needed if the UK’s economic outlook deteriorates.
McCafferty specified that if the economy decelerates in line with the initial survey signals, then additional easing is likely to be warranted with the BoE cutting rates further. He also said that the bank should follow a steady approach in its reaction given that post-referendum figures are still inadequate.
The pound dropped following these remarks, perhaps because he is a well-known hawk within the MPC who also disputed the August decision to launch further QE, though he did vote for a rate cut. Therefore his remarks imply that even the most hawkish MPC members are open to further easing if the data are generally in line with the bank’s inflation report estimates, thus make future easing seem more likely.
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Considering the BoE’s easing bias, the short-term position for the pound remains negative. Slowing investment inflows to the UK in coming months could cause the nation’s current account deficit to widen more somewhat that could add even more strain on sterling.
Other factors contributing towards the sterling’s decline since the 4th of August include the first BOE rate cut since 2009 and the launch of more than the projected scale of QE. Also, the robust nonfarm payroll figure released on 5th Aug resulted in the strengthening of the dollar against sterling and other currencies.
The manufacturing sector which accounts for roughly around 10% of the UK GDP has also seen fading demand and job cuts. In July, the sector posted the quickest slowdown in three years, stemming from uncertainty and reduction of orders. The softness of sterling drives up the cost of imported materials while the benefits in terms of price competitiveness for finished goods often takes longer to be attained. Foreign investment will also likely decline due to the indefinite business environment, will likely hit the demand for labour force.
After the Brexit vote, overall economic data has disappointed, such as the Services PMI and Manufacturing PMI released on 25th July both pointing to a contraction and economic slowdown. In addition, the current account deficit of the UK is about 7% of the GDP, which is higher than most developed countries and is weighing on the sterling.
Therefore the aftermath of the Brexit vote, the large trade balance deficit, the BoE’s rate cut and stimulus measures, as well as the strengthening of the dollar result in the long term mean that sterling is likely to be bearish potentially heading towards post-Brexit lows.