The Pound to Euro exchange rate plummeted by over 150 pips last week and could suffer further losses this week as the Bank of England (BoE) gears up for lower interest rates.
Soft Data Prompts Dovish BoE Rhetoric
Demand for Sterling floundered at the start of last week’s session in response to comments from BoE policymaker Martin Weale calling for ‘immediate stimulus’. The dovish remarks were particularly concerning because Weale had initially stated that it was too early to judge the impact of the ‘Brexit’ vote. GBP/EUR tumbled from just under 1.20 to just under 1.19 in reaction to the statement. The single currency was also helped by news that UK manufacturing firms were more worried about business prospects than at any time since the height of the global recession in 2009.
On Wednesday second quarter UK GDP printed at 0.6%, beating expectations of 0.5% and up on 0.4% in Q1. However, the upbeat score failed to lift demand for the Pound even though industrial output accelerated at the fastest pace since 1999 at the beginning of the year. The problem was that almost all of the growth took place in April, with the economy grinding to a halt in May and June in anticipation of the EU referendum. Investors are fearful that the downtrend will worsen following the historic vote.
The dovish BoE rhetoric intensified on Thursday, with policymaker David Blanchflower hinting that the central bank could eventually push interest rates into negative territory. Sterling slid 100 pips to 1.18 in response to the remarks as futures traders priced a near 100% chance of a 25 basis point rate cut from the BoE on August 4.
How Low Will The BoE & Pound Go?
Sterling remained soft over the weekend and sentiment suffered at the start of the week as UK manufacturing output in July was downgraded to a three-year low of 48.2.
Having been burned in July, when the BoE intimated it was ready to slash rates but didn’t, markets have not fully priced the prospect of a 25-point basis cut into the Sterling exchange rate. This means that GBP/EUR is liable to depreciate on Thursday if the central bank does indeed cut rates for the first time since 2009. It also means that Sterling could sustain even greater losses if the BoE opts to embark on a more substantial stimulus programme. Options include a 50-point rate cut, negative deposit rates, additional quantitative easing funds and even printing money for citizens to directly stimulate economic activity.
In summary, the Pound to Euro exchange rate could lose around 50-100 pips if the BoE cuts rates by 0.25%. GBP/EUR could succumb to a post-referendum low if the central bank cuts rates and embarks on a new QE scheme, and Sterling could strike a new three-year low if BoE policymakers decide to unleash an aggressive stimulus programme of negative rates, additional QE and other unconventional measures.
Conversely, if the bank shocks markets and remains on the sidelines then GBP/EUR could surge back above psychological resistance at 1.20.