Jason Heppenstall

Pound struggles as BoE hints at rate cut – FED actually cuts lending rates by 50 BPS in shock move


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The Pound spent much of the month of February climbing on currency markets as traders generally sought out safe haven in reaction to the coronavirus scare centred on China. This, however, came to a crashing halt at the beginning of this month when the Bank of England (BoE) hinted that UK interest rates may need to be cut.

CARNEY WARNS OF “DISRUPTION NOT DESTRUCTION”

While the BoE had opted to keep interest rates steady at 0.75% at the end of January, it was only a month before talk surfaced of cutting them to help struggling businesses dealing with the fallout from the coronavirus.

Bank Governor Mark Carney warned the G-7 that the UK could face an economic shock that could be “large” but which he hoped would be “temporary”. He added that the virus would cause “disruption not destruction” and ruled out heading into negative interest rate territory as a policy tool.

Earlier comments from the Bank had seen Sterling relinquish the gains it had made against the US Dollar and the Euro over February, leaving GBP/USD and GBP/EUR trading at $1.28 and €1.14 respectively.

SHOCK RATE CUT FROM FED’S POWELL SEES USD RISE HALTED

The US Dollar has been the currency which has shown the most resilience in the face of the spread of the virus. Despite this, on March 3 the US Fed opted to cut interest rates by 50 basis points, halting any further falls for the Pound.

This is the first US interest rate cut since 2008 and it surprised traders in both its timing and its size. A dovish sounding Federal Reserve Chair Jerome Powell explained the decision, saying that the coronavirus threat “poses evolving risks to economic activity” adding:

“In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1 1/4 percent.”

The emergency cut comes after a global stock market meltdown at the end of February caused by panicky traders dumping equities. This immediately saw traders snapping up safe US treasuries, which had the effect of strengthening the US Dollar.

Previously adding to the Dollar’s resilience were some strong US fundamentals and a sturdy US non-farm payrolls report, causing the GBP/USD currency pairing to sink from a high of $1.30 down to $1.28.

Elsewhere in North America, the Pound has been up and down against the Canadian Dollar over the course of February, with GBP/CAD rising to CA$1.73 as the oil price continued to plummet – with WTI crude down to $47.5 a barrel – due to decreased demand across Asia. By the start of March, the value of the Pound against the ‘Loonie’ had fallen back again to around CA$1.71.

STRUGGLING AUSTRALIAN DOLLAR GETS A SHOT IN THE ARM FROM RATE CUT

The Australian Dollar has been having a tough time of it due to slumping demand for commodities from China – Australia’s biggest trading partner – seriously denting AUD exchange rates.

The Reserve Bank of Australia threw out a lifeline on Tuesday March 3, slashing lending rates to a new all-time low of 0.5%.

While cutting interest rates would normally weaken a currency in this case it had the reverse effect, causing the commodities-linked ‘Aussie’ to jump.

The strengthening of AUD was ascribed to the fact that markets saw it as a sign there would be a broad-based monetary response to the virus outbreak, with the central bank indicating that it also expected targeted fiscal relief for those sectors hardest hit by the slump.

It remains to be seen how long this good cheer will last, however, meaning the broader outlook for the GBP/AUD exchange rate remains positive. Traders will be keeping a close eye on Chinese manufacturing output data over the coming weeks to see just how bad the hit to businesses has been during February, with any downside shocks liable to sink AUD further.

The New Zealand Dollar could be in for a similar ride, with GBP/NZD trending around NZ$2.03 at the start of March.

EURO MIXED AS INVESTORS HESITANT OVER VIRUS FEARS

With the Euro being the world’s second reserve currency, a number of factors have impacted the currency over the last month, causing it to weaken and then strengthen against the US Dollar and others.

One of the main weakening factors was of course the coronavirus outbreak, with the appearance of a cluster of infections in northern Italy spooking traders.

The fear is that if Italy suffers much economic damage from the virus, its banks will need to be bailed out by the European Central Bank (ECB), which will cause political problems in the currency bloc. There would then be further worries about the Italian government technically exceeding its EU mandated budget constraint if GDP were to fall, as seems likely.

However, over the latter half of February these fears were outweighed by positive factors, the strongest being the ECB – which unlike other central banks – said it did not have any plans to cut interest rates (which are already at 0%).

Nevertheless, in what may be something of a reversal, the ECB hinted on March 2 that it may join other central banks and take action after all, stating it “stands ready to adjust all its instruments, as appropriate.”

The upshot of all this is that the EUR/USD exchange rate rose from a mid-February low of $1.08 to $1.12 after the Fed rate cut decision.

Meanwhile, more tough talk from the UK and the EU over Brexit negotiations continued to impact the Pound, with GBP/EUR falling back to €1.14 at the time of writing.

COMING UP IN MARCH

The key factor driving the Pound at the moment is the likelihood of a rate cut from the Bank of England to deal with any fallout from the spread of coronavirus. What’s more, the budget on March 11 will give traders something to focus on, with all eyes on new chancellor Rishi Sunak, who is expected to be bold in his policy announcements. On March 15 long-time Governor Mark Carney will step down from the Bank of England to be replaced by Andrew Bailey.

10TH MAR (GBP/EUR): Eurozone Q4 2019 GDP
11TH MAR (GBP): UK GDP, industrial production and growth
12TH MAR (GBP/EUR): ECB interest rate decision
15th MAR (GBP): Bank of England Governor Mark Carney stepping down to be replaced by Andrew Bailey
18th MAR (GBP/USD): US Federal Reserve interest rate decision
24TH MAR (GBP): UK Markit Services PMI (Mar)
24TH MAR (GBP/EUR): Eurozone Markit Services PMI (Mar)
26TH MAR (GBP): UK Bank of England interest rate decision
26TH MAR (GBP/USD): US Q4 2019 GDP