gbp fundamentals

British Pound Shows Signs of Life as Gilts Yields Rocket Higher

Monday, 05 January 2009 21:44:08 GMT  |  Terri Belkas, Currency Strategist

The British pound has spent most of December drifting toward support at 1.4400, as the markets anticipated that the Bank of England will continue cutting rates aggressively. This also led 2-year gilt yields to fall to record lows on Friday, but they made a comeback on Monday on speculation that the Bank of England will expand the 200 billion pound program that allows banks to buy illiquid securities in exchange for government debt. This seems feasible, as the minutes from the BOE’s December 3-4 meeting show that the Monetary Policy Committee though that the “Bank Rate was not the right policy instrument to tackle supply constraints in the credit market” and that additional “measures to underpin lending growth would be needed, building on the Government’s package announced in October to recapitalise and guarantee funding to the banks.” It will be important to gauge price action in the UK fixed income markets this week, as the rise in 2-year gilt yields by 7 basis points at 1.84 percent and jump in 10-year gilt yields of 12 basis points to 3.15 percent coincided with broad gains in the British pound. In fact, the currency gained more than 1 percent against the US dollar, 2.74 percent versus the Japanese yen, and over 3 percent against the euro and Swiss franc.

Of course, bearish risks linger for the British pound ahead of the BOE’s next rate decision on January 8 at 7:00 ET, as Bloomberg News is forecasting that the Bank of England will cut rates by 50 basis points, while Credit Suisse overnight index swaps are only pricing in a 25 basis point reduction. We already know that the UK economy is in recession and most expect it to get worse, but a rate cut seems even more likely when considering the latest study by the BOE. The BOE’s Credit Conditions Survey for the fourth quarter indicated that the situation had indeed deteriorated, with the availability of loans down despite unexpectedly stable demand for mortgages. Furthermore, the survey said that spreads on secured lending to households and on corporate lending had widened, while defaults on household and non-financial business loans had increased. However, the reaction of the British pound may depend on what sort of bias is reflected in the Monetary Policy Committee’s subsequent statement, because as we saw with the December 4 rate cut by the BOE, the currency could actually rise following a rate cut.

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