Pound Sterling plunges as vulnerable PMI deepens recession risks

Pound Sterling drops significantly as investors see the UK economy shifting into a recession.
UK recession fears deepen as BoE warns about rising corporate default risks.
Investors await the Jackson Hole Symposium for further guidance.

The Pound Sterling (GBP) witnessed a breakdown of the consolidation formed above 1.2700 as bullish market sentiment failed to neutralize the impact of vulnerable British PMIs reported by S&P Global on Wednesday. The agency reported that factory activities were at their lowest since the pandemic period as firms underutilized their operating capacity due to a bleak demand outlook.

Fears of a recession in the UK economy deepened on Wednesday as warning from Bank of England (BoE) policymakers about significant upside risks to corporate defaults strengthened after the release of vulnerable PMIs. Deepening recession fears are forcing investors to bet on a lower interest rate peak. A poll from Reuters shows that the BoE could pause the rate-tightening spell after an interest rate hike in September.

Daily Digest Market Movers: Pound Sterling falls vertically ahead of Jackson Hole

Pound Sterling delivers a breakdown of the consolidation formed above the round-level support of 1.2700 as recession fears renewed
The strength in the Pound Sterling shows that investors are ignoring vulnerable UK preliminary PMI figures for August, reported by S&P Global on Wednesday.
S&P Global reported UK Manufacturing PMI dropped significantly to 42.5 from estimates of 45.0 and July’s reading of 45.3. This has been the lowest factory data figure since the pandemic period and demonstrates the consequences of higher interest rates by the Bank of England.
Services PMI shifted into the contraction phase below the 50.0 threshold. The economic data landed at 48.7, lower than estimates of 50.8 and July’s release of 51.3.
On Tuesday, BoE policymakers warned about significant upside risks to corporate defaults amid higher interest rates. The current tightening cycle by the BoE is aggressive as inflation in the UK is the highest among developed nations.
A survey from the BoE shows that the share of non-financial UK companies experiencing a weak debt-service coverage ratio will rise to 50% by year-end from last year’s reading of 45%.
Consistently declining factory PMI indicates that UK firms are not operating at full capacity due to a poor economic outlook.
Declining PMIs have deepened fears of a recession in the UK economy. This has forced traders to bet on a lower interest rate peak.
According to a Reuters poll, the BoE will raise interest rates one more time on September 21 by 25 basis points (bps) to 5.50%. A minority of economists expect rates to go even higher.
Significant upside risks to corporate default and vulnerable PMIs are expected to push the UK economy into a recession sooner but BoE policymakers seem helpless and cannot avoid raising interest rates as price pressures are well in excess of the desired rate of 2%.
The market sentiment turned bullish after the United States' preliminary PMI remained weaker than anticipated, indicating that the economy is losing its resilience.
The market mood could turn cautious ahead as the Jackson Hole Symposium will start on Thursday. Federal Reserve (Fed) Chair Jerome Powell is expected to provide an outlook on inflation, interest rates, and the economy.
The US Dollar Index (DXY) turns sideways around 103.30 after a sell-off move ahead of the Jackson Hole event. Apart from that, investors will keenly focus on the Durable Goods Orders data.
Former St. Louis Fed President James Bullard said on Tuesday that the US economy faces novel risks of stronger growth. This could warrant higher interest rates from the central bank to keep up the fight against inflation.

Technical Analysis: Pound Sterling recovery fades, declines toward 1.2600

Pound Sterling falls back after a solid recovery move as investors await the Jackson Hole Symposium for further action. The Cable recovered sharply on Wednesday after forming a Triple Bottom chart pattern around 1.2613 but investors capitalized the pullback move as a selling opportunity. For a confident bullish reversal, the asset has to overstep the round-level resistance of 1.2800. The Cable is consistently failing to close above the 20 and 50-day Exponential Moving Averages (EMAs).

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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