Concerns over Greece’s credit rating and large budget deficit sparked a flight to safety as fears grew that it could become a contagion for Europe and beyond. Broad based dollar and yen
support saw sterling lose ground to the funding currencies. Pound
fundamentals and a dovish BoE added to the bearish momentum. The U.K. economy barely emerged from the recession with growth of 0.3% in the fourth quarter fueling concerns that the economy could fall back into contraction. Inflation over the central bank’s 3.0% threshold had raised expectations that the MPC would bring an end to their asset purchase program at their February rate decision. However, Governor Mervyn King shortly after the policy decision stated that although the BOE had paused QE, “it is far too soon to conclude that no more purchases will be needed.” Minutes from the meeting would confirm the dovish outlook stating that the board maintained the option to “provide further monetary stimulus” as they see the economy facing “considerable” headwinds over the coming months. Mortgage approvals dropping to an eight month low raised speculation that more QE could be forthcoming which sunk the cable further.
Where Are We Headed?
DailyFX analysts continue to see downside risks for the pound with several holding onto existing short positions. Others are heading to the sidelines as current consolidation across most pairs has yielded very little attractive set-ups. Looking at recent U.K. fundamentals we can see why a bearish bias may be warranted. Industrial production fell 0.4% in January, with falling exports leading to a wider trade deficit. The PMI readings for manufacturing and construction both slipped pointing to a slowdown in the sectors. The only positive was an improvement in the service sector which does account for 70% of the economy. However, the BoE remained on hold for another month and next week’s release of their policy meeting minutes could show that the door is open for more QE which could extend the current bearish trend. We can see in the chart below that interest rate expectations fell sharply from the beginning of the year when overnight index swaps were pricing in 93 bps of tightening. Yet, the outlook has brightened since a low of 32 bps on 2/5 with markets now seeing 50 bps of rate hikes in the next year. To discuss this and trading ideas join the GBP/USD forum