Bank of England Plays Catch-up at Expense of Sterling

by Ashraf Laidi
Nov 6, 2008 14:54 | 9 Comments

The Bank of England's shocker 150-bp cut to 3.00% (lowest level since 1955) against expectations of 50-bp cut is the biggest rate cut since the central bank acquired operation independence 11 years ago. The Swiss National Bank also surprised with an unscheduled 50-bp rate cut to 1.75%. The European Central Bank stuck with a widely expected 50-bp cut to 3.25%. ECB president JC Trichet says the bank does not rule out further rate cuts and cannot rule out sharp decline in inflation next year.

Bank of England Plays Catch-up at  Expense of Sterling - Globalrateslongterm (Chart 1)


UK interest rates are now below those of the Eurozone for the first time in the life of the euro. Today's 150-bp cut is a serious assault to the British pound's central bank reserve currency role
. After the BoE announcement, GBPUSD collapsed by a full 2 cents in less than 3 minutes to $1.5710 before jumping back by more than 3 cents towards $1.6020 and later dropping back towards $1.5850s, as surging volatility widens price spreads and impacts liquidity. We now expect GBPUSD to gradually find its way down towards $1.58 and onto $1.57. There lies more downside towards $1.5350, even in the event of further gloom in tomorrow's US jobs report.

The chart below shows sterling's trade weighted index hiting its lowest level since November 1996. Just yesterday, the UK's National Institute of Economic and Social Research estimated Q3 GDP to have contracted by 0.5% from an initial estimate of a 0.2% contraction, expecting the downturn will last into 2010.

Bank of England Plays Catch-up at  Expense of Sterling - Gbperi (Chart 2)

The magnitude of today's interest rate moves from UK and Switzerland not only reflects the gravity of the financial and economic dangers in Europe and their impact on the rest of the world, but also manifests the lateness of UK central bank policy makers, whose inflation-focus had clouded their ability to weigh the depth of the recession. Despite having acquired operational in May 1997, the Bank of England remains bound to a government-imposed inflation target (not ceiling as in case of ECB), now at 2.0%.

Pre-Jobs Central Bank Action? The global fallout from yesterdays 5% slump in Wall Street ought to have played a role in forcing the hand of the BoE into making todays historic move. Tomorrows US non-farm payrolls for October are expected to show a loss of more than 220K (biggest since November 2001), while the unemployment rate hitting a fresh 5-year high of 6.3%. A rate above 6.3% would be the highest since 1994. Yesterdays ADP report on private payrolls showed a decline of 157K in October (highest since Nov 2002). The impact on US and global markets of such a report could be of escalating volatility, favoring the lower yielding currencies.

Comments (Showing latest 9 of 9) View All Comments
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Dec 3, 2008 19:08
Ashmil,

The big difference in EM currencies today with 10yrs ago is that the Asians have huge amounts of fX reserves on hand. But some problem currencies in Easter Europe may bear more of the brunt of speculative attacks. Having said that, it's important to note that many big spec players are stilll licking their wounds from the overall market volatility so it's doubtful that they could mount the same as was done in 1998.
Ashraf
Ashmil Laidi
Kuala Lumpur, Malaysia
Posted Anonymously
11 years ago
Dec 1, 2008 16:34
Ashraf

What's your opinion on the emerging markets' currencies? Any possibilities to be manipulated by rogue speculators again?
David
Tennessee, United States
Posted Anonymously
11 years ago
Nov 27, 2008 13:33
Ashraf,
Have really enjoyed and benefited from following your analysis for several months.
Have seen your call for GBPUSD to target 1.62 by year end if it can get by critical resistance at 1.58. On daily charts, 62% fibonacci of last move down from 1.6671-1.4557 is at 1.5857; 79% fibo at 1.6214. Why do you predict 1.62 vs. 1.58 target for year end? Thanks very much.
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 10, 2008 0:46
Simon,

EURGBP directional trade remains up as UK rates will remain below Eurozone for a much more and that's the first time in the life of the euro. The notion that ECB will not have to cut rates by as much as BoE is a major factor. The fact that the ECB's inflation mandate is set by the ECB itself whereas the BoE's inflation target is set by the GOVERNMENT suggests that the govt will let the inflation priority pass for now because it is the very target that it had imposed is the main reason behind the deepening UK recession--resulting from BoE's refusal to inject liquidity immediately after Northeren Rock, etccc... EURGBP seen at 0.8160
Simon
Harrogate, UK
Posted Anonymously
11 years ago
Nov 9, 2008 20:23
Hi Ashri,

Just found your site via Seeking Alpha.

Some bears reckon that the UK will need to call in the IMF as the economy shows sign of serious structural collapse over the coming months. The debt fuelled Service Sector multiplier will go into reverse, with GDP falling -3%+ during 2009.

If you sat in the pound which currencies look solid?

I have got the USD & NOK.

My sense is that the USD will continue to be the big directional trade.

I can't work out how the Euro/Sterling is going to pan out.

Thank you

All the best.
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 7, 2008 15:34
Frank,

Gold's prospects will improve at the first sign of stability in the world economy (not nececessarily US economy). Once US interest rates drop to 0.50%, the system will be ultra liquified, and i dont see the situation as bad as in Japan, where banks simply hid bad debts under the desk and let them rot for years. US banks/govt are at least taking some hard measures. dollar to remain low yielding currency, which means it will underperfom during every upcoming bout of carry trade building.
Frank
Vancouver, Canada
Posted Anonymously
11 years ago
Nov 7, 2008 2:51
Ashraf

With interest rates being cut to zero world wide like Japan did in the 90's .. What happen's to the U.S dollar in a depression or a Japan like situation world wide and which currency would be best to hold under such circumstanaces ? Would holding gold be a good idea in a world depression ?

Thanks

Frank
Ashraf Laidi
London, UK
Posts: 0
11 years ago
Nov 6, 2008 17:23
Steve,

Like I said in the article, GBPUSD downside is inevitable. $1.55 will be seen again. You have to realize that old fashioned fundamentals do not apply in currency reactions to wild policy moves such as today's, which happen every 30-40 years.

Hamish,

in response to your question in the previous article, yes, i expect the dollar decline to be temporary later in the year coinciding with bear market rally in stocks. $1.37 is the max target for the euro during the upcoming equity bounce.

Ashraf
Steve
New York, United States
Posted Anonymously
11 years ago
Nov 6, 2008 16:52
Ashri,

With such a huge rate cut, this GBP/USD is strong as an OX. Unreal!!??

EUR/USD more predictable.

How low will GBP/USD go? Please update. As always, thanks.

Steve Tan - ex-cmc customer in NYC