The Pound Sterling (GBP) demonstrates caution at the start of this week as investors remain uncertain over the UK’s economic outlook. Expectations abound of one more interest rate increase from the Bank of England (BoE), a decision that will be announced on Thursday. The BoE is not in a position to pause the policy-tightening spell as inflationary pressure is stubborn and wage growth momentum is strong.
Before the BoE interest rate decision, investors will keenly watch the inflation data, which is scheduled for Wednesday. The headline Consumer Price Index (CPI) is expected to accelerate due to higher energy prices as global oil prices have rallied in the past four months. Core inflation is almost stable due to a higher labor cost index. Market participants seem uncertain whether UK PM Rishi Sunak will fulfill his promise of halving headline inflation to 5% by year-end. The promise of halving inflation to 5% was made by Sunak when headline inflation was at a double-digit figure in January.
Pound Sterling trades back and forth near a three-month low of around 1.2370 as investors see a vulnerable economic outlook for the UK economy on expectations of one more interest rate increase from the BoE this week. The Cable seems broadly bearish, trading below the 200-day Exponential Moving Average (EMA), which is at 1.2490. Downward-sloping 20 and 50-day EMAs indicate that the short-term trend is bearish. Momentum oscillators also indicate strength in the bearish impulse.
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).
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.
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.
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.