GBP/USD downside risks prevail ahead of BoE this week

GBP/USD is currently trading around 1.2440 and flat on the day in a lacklustre Tuesday in markets as sights are set on bigger events later this week. GBP/USD has been very uneventful in the New York session, so far, and has ranged between a low of 1.2420 and a high of 1.2483 on the day.  

Markets don't really know what to make of the recent escalations in the US and Chinese stand-off. It comes at a time where COVID-19 has forced governments and central banks around the world to respond with a fiscal and monetary easing of historical dimensions. The initial risk-off at the start of the week has all but been reversed in the financial and commodities markets – (S&P +1.90%, CRB Index +4.25%).

As far as the economic damage already inflicted on the global economy, looking at Gross Domestic Product for Q1, this has already revealed declines of 9.8% QoQ in China, -3.8% in the euro area and -1.2% in the US. While there seems to be some cautionary optimism being priced into markets due to nations and some US states opening their economies back up, slowly, there is still a looming risk of a second wave which is likely to keep uncertainty high. Therefore, small positive steps being made on the charts are likely to be thwarted by giant leaps to the downside on any negative outcomes. It will not be until a vaccine or effective treatment of the COVID-19 disease is on the horizon, with the help of stimulus, that the road towards normalisation can be more assured. 

UK GDP forecast of -6.0%

At this juncture, a sharp global recession from prolonged lockdowns is on the cards and when looking to the UK, a 2020 UK GDP forecast of -6.0% (previously -3.0%) has been made by analysts at Standard Chartered:

• We lower our 2020 UK GDP forecast to -6.0% (previously -3.0%); raise 2021 forecast to 4.9% (from 3.0%);
• We expect GDP to contract by 3.4% q/q in Q1 followed by a larger decline of 12.6% in Q2;
• An economic recovery is anticipated in Q3 and Q4, but risk of a secondary epidemic remains high;
• Failure to reach a UK-EU trade agreement within transition period would exacerbate the downturn.

BoE forecasts will be key

This brings us to the Bank of England this week. The Monetary Policy Committee is expected to keep the benchmark interest rate unchanged at 0.10% at this week’s meeting. The rate decision and the Monetary Policy Report will be published in the early morning at 7 AM London time; a briefing will be made public at 10 AM.

Analysts at Rabobank argued that "the path towards a negative policy rate hasn’t opened up yet, and the OIS forward curve is almost completely flat due to the lockdown measures."

Even as there are no expectations for policy changes going into this meeting, the MPC’s outlook will gather a lot of interest. We will see the first set of official forecasts that incorporates the impact of the Covid-19 pandemic. While we think that the Bank of England will eventually have to increase the size of its Asset Purchase Facility again, we only expect such a decision at the June meeting.

What the analysts touched on there is key, "the MPC’s outlook will gather a lot of interest." One would expect the MPC to push back on the idea of a ‘V-shaped’ recovery this week and that in itself will be detrimental to the pound. Businesses can not just get back to work in full capacity – the process of doing so will be very slow. Businesses will be reluctant to hire staff in this climate where a second wave of the virus and subsequent economic lockdowns is a probability. If things did not look bad enough for the pound going forward, and despite the UK's own political strife with Europe, it now might have to contend with dollar strength. There is upside risk again for the greenback stemming from a trade war flare-up between the US and China. 

Tradewars part deux 

You'll be reminded that at the start of his week, there was an initial bout of risk-off which supported the US dollar, sinking GBP/USD from 1.2484 to 1.2405. Well, there will likely be more to come in the weeks ahead with Washington engaging in a so-called new Cold War with Beijing.

The American hawks are back, now criticized China for downplaying the impact of the COVID-19. Politicians such as the US Secretary of State, Mike Pompeo, insists on accusations that the virus originated in a laboratory in Wuhan, Central China's Hubei Province. More on that here: What you need to know as markets open: Pompeo and Trump ratcheted up US and China tensions

As US President Donald Trump continued elevating China's "culpability" for the epidemic, his administration is also reportedly mulling an initiative to remove global industrial supply chains from China and weighing new tariffs to renew a trade war. 

The Global Times wrote in an article today which states that, "part of the US-initiated trade war strategy under Trump is reportedly reducing US reliance on China and urging companies to move their production out of the country.

GBP/USD levels