Next week’s BoE meeting will be a major driver for the pound sterling.
The odds of a cut are 50/50, which means the reaction will be significant as a cut or hold are rapidly priced in.
EURGBP has been climbing this week on negative euro data. The FTSE also made a strong reversal higher. This suggests the market may be favouring a cut.
It has been a special week in many ways. USDJPY crashed –3.5% into Thursday’s lows, the S&P500 made its largest one-day decline for over a year, and the Nasdaq its largest one-day decline for two years. The reasons aren’t immediately clear and seem to stem from concerns technology stocks such as Nvidia are priced too high. With the world economy slowing, valuations suddenly seem to matter.
European markets have been less volatile and the FTSE put in a solid reversal from a new July low on Thursday to rally back 2.5%. This was accompanied by some sterling weakness and these both suggest the markets are warming to the idea the BoE may cut in next week’s meeting after all. EURGBP has climbed to 0.843 even though euro data has been weak.
Sterling Sliding Ahead of the BoE
The pound remains the best performing G7 currency this year, but it has started to soften in recent sessions. This is best illustrated by the recovery in EUDGBP which has recovered from a July low of 0.838, back over 0.84 to trade at 0.843. While this is not yet a significant move, the backdrop suggests it may signal something important ahead of the BoE meeting next week.
Data this week suggests the opposite move should have taken place as EU PMIs missed estimates and reflected a sluggish economy. While they are only one data point, they did suggest the ECB should think about further cuts sooner rather than later. UK PMIs, on the other hand, impressed and suggested the BoE should feel no pressure to cut as soon as next week’s August meeting.
The fact the EURGBP moved higher rather than lower may suggest growing expectation of a cut. As ING note,
“…we expect a broad-based GBP weakening next week when the Bank of England will – in our view – cut rates.
…in short, we think the BoE will judge the stickiness in services inflation as down primarily to one-off factors and may look at more “core” measures that instead point to a less worrying picture. Market pricing (-13bp) suggests there is room for a GBP correction.”
This last point is important as the odds of a cut have been low since CPI came in higher than expected earlier in July. With only 13bps priced in of a potential 25bps, the markets is 50/50 on whether the Bank ease or not. Should they deliver, the pound would likely drop sharply and EURGBP could challenger 0.85 again.
Euro Holding Up Well
As already mentioned, the euro has had to navigate some negative data this week. PMIs came in lower than expected and indicated the manufacturing sector remains in contraction. German data was particularly weak and this was highlighted again by the Ifo Business Climate Survey release. Yet, the euro has been steady and even gained against 4 of the G7 currencies.
The solid performance is likely due to the euro being fairly priced for two cuts this year. This week’s data certainly supported the view of another cut, but wasn’t enough to convince markets the ECB will commit to a third. Inflation remains sticky so the economy would really have to roll over before the focus shifts from controlling inflation to stimulating growth.
Should there be encouraging news on inflation in the coming months, the ECB could well cut a third time, but this won’t be clear for some time and the euro could hold up for now. EURGBP looks comfortable in a 0.84-0.85 range and EURUSD is stable between 1.08 and 1.09.
