Pound Sterling drops vertically as persistent core inflation deepen recession talks

Pound Sterling surrenders recovery as more interest rate hikes from the BoE are warranted for the achievement of price stability.
The UK housing sector faces the wrath of higher mortgage rates.
Rishi Sunak plans for cabinet reshuffle sooner ahead of general elections.

The Pound Sterling (GBP) fails to maintain auction near a fresh three-day high, as market sentiment turns bearish ahead of S&P Global preliminary PMI data for August and expectations of more interest rate hikes from the Bank of England (BoE) to ensure price stability. Earlier, the GBP/USD pair picks strength as investors hope that the current tightening cycle of the BoE will surpass the tightening peak by the Federal Reserve (Fed).

Higher borrowing cost by the BoE widens its scope of consequences to the United Kingdom’s property sector. Homebuyers have been witnessing an affordability squeeze due to higher mortgage rates as strong wage growth struggles to offset higher installment obligations. The Pound Sterling is expected to remain in action as UK PM Rishi Sunak is planning a big cabinet reshuffle ahead of general elections in 2024.

Daily Digest Market Movers: Pound Sterling fails to sustain recovery as market mood dampens

Pound Sterling faces selling pressure after failing to sustain above 1.2800 as investors’ risk appetite weakens ahead of preliminary PMIs data for August.
UK’s S&P Global PMI data will be released on Wednesday at 08:30 GMT. Manufacturing PMI is seen declining to 45.0 vs. the former reading of 45.3. Services PMI is expected to remain steady at 52.3.
After July’s economic data, investors hope that the Bank of England cannot pause its rate-tightening cycle so that inflation returns to 2%.
Strong wage growth allows households to spend heavily and core inflation to remain stubborn. UK core inflation remains steady at 6.9%, marginally lower from its peak of 7.1%.
Headline inflation softened sharply to 6.8% from June’s figure of 7.9%. Fuel sellers stopped overcharging consumers after being warned by BoE Governor Andrew Bailey.
Meanwhile, Fitch said that energy and food inflation in the UK are likely to fall further in the coming months due to base effects.
Considering the current inflation situation, UK PM Rishi Sunak may not fulfill his promise of halving inflation to 5% by the year-end.
The BoE is expected to raise interest rates further in September and the interest rate peak is forecast at 5.75%.
The consequences of 14 back-to-back interest rate hikes by the UK central bank have slowed consumer spending momentum. Retail Sales dropped in July due to wet weather as high inflation has squeezed the real income of households.
The impact of restrictive monetary policy has widened to the entire property sector. Major mortgage lender Halifax showed that home affordability has shrunk significantly as stronger wage growth fails to offset higher borrowing costs.
Discussions about UK’s cabinet reshuffle remained hot this weekend. Reuters reported that PM Sunak is now considering focusing on replacing ministers who have already said they want to step down, such as former Defence Secretary Ben Wallace.
UK cabinet reshuffle is expected to happen sooner as Rishi Sunak is failing to fulfill his promise of halving inflation and strengthening economic prospects ahead of general elections scheduled for 2024.
The US Dollar Index (DXY) rebounds sharply after a lackluster performance ahead of the Jackson Hole Economic Symposium, which will start on Thursday.
Investors hope that Fed chair Jerome Powell may not discuss hiking interest rates without any compelling economic data but will deliver a strong message of achieving price stability by keeping interest rates higher for longer.
The upside momentum in US Treasury yields has slowed down as Jerome Powell is likely to discuss keeping interest rates neutral at the September policy meeting.
Moody’s, S&P Global have downgraded the credit ratings of US commercial banks, citing risks of rising outflows in a high-interest rate environment.

Technical Analysis: Pound Sterling drops sharply from 1.2800

Pound Sterling drops after printing a fresh three-day high around 1.2800, as the US Dollar resumes its upside journey. The Cable has been trading in a range of 1.200-1.2800 for the past three weeks, and an explosion of the same will result in wider ticks and heavy volume. On a daily time frame, the asset has managed to climb above the 20 and 50-day Exponential Moving Averages (EMAs), which indicates that the mid-term trend has turned bullish.

BoE FAQs

What does the Bank of England do and how does it impact the Pound?

The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).

How does the Bank of England’s monetary policy influence Sterling?

When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.

What is Quantitative Easing (QE) and how does it affect the Pound?

In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.

What is Quantitative tightening (QT) and how does it affect the Pound Sterling?

Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.

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