British Pound: Sterling stability challenged by narrowing carry – Deutsche Bank

Deutsche Bank’s Shreyas Gopal notes that Bank of England (BoE) meetings have repeatedly seen early market speculation on tightening fade as decisions approach, keeping the Pound stable and EUR/GBP in a narrow range. However, he warns that a likely 6-3 vote to hold rates and unchanged guidance may now trigger Sterling weakness as its carry advantage versus the Euro erodes.

Sterling stability faces new headwinds

"Each meeting finishes with some degree of excitement around whether the next meeting could be the one where the MPC starts to tighten. But as the meeting draws closer, pricing decays towards zero and instead gets pushed further out the strip."

"This pattern is broadly consistent with the “buying time” strategy from the Bank of England this year. Normatively speaking, this has been an appropriate response to a supply-driven inflation increase, and in a context of still (mildly) restrictive UK monetary policy and uncertainty over the labour market trajectory."

"From a currency perspective, this strategy has also been successful in keeping the pound very stable."

"Nevertheless, this delaying strategy may have run its course for the pound. A 6-3 vote to hold, and largely unchanged forward guidance – as our economists expect – is now unlikely to be sufficient in preventing some sterling weakness."

"Sterling’s carry advantage against the euro is starting to narrow as the ECB tightens, and has peaked even after adjusting for the fall in implied vol."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)