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Brexit Briefing: Brexit to Drive GBP Now UK Rates Have Risen

Brexit Briefing: Brexit to Drive GBP Now UK Rates Have Risen

Martin Essex, MSTA, Analyst

Talking Points

- The progress (or lack of it) in the divorce proceedings between the UK and the EU is likely to be the main driver of the British Pound now the post-referendum cut in UK interest rates has been reversed.

- Any further rate changes are now some way away so traders can safely move their focus from monetary policy to the Brexit negotiations.

What Does the Fourth Quarter Hold for the Pound, Equities, Oil and Other Key Markets? Find out here

The Bank of England’s decision to increase UK Bank Rate for the first time in more than 10 years, reversing the precautionary cut made after the Brexit referendum in June last year, leaves traders in the British Pound free to concentrate on the Brexit negotiations rather than UK monetary policy.

After raising the benchmark rate to 0.5% from 0.25%, the bank said any further increases would be “at a gradual pace and to a limited extent”, suggesting extreme caution: it is not inclined to hike rates further while UK economic growth remains underwhelming. This was emphasized by the fact that both of the bank’s deputy governors, Jon Cunliffe and David Ramsden, voted against it.

That means market expectations of just two more quarter-point rate increases over the next three years, taking Bank Rate to a still-modest 1%, are probably about right. If monetary policy is therefore on the back burner, the progress of the Brexit talks between the UK and the EU is therefore likely to be the principal driver of the British Pound in the months ahead.

If so, the equation is straightforward: steps, however small, towards a deal – or at least towards an agreed transition period – should be positive for the Pound while setbacks should be negative. Indeed, it is clear that the bank will be watching the negotiations closely as it said that “considerable risks remain”, including those associated with Brexit.

Therefore, any setbacks – particularly if “no deal” becomes increasingly likely – will make the bank even less inclined to tighten UK monetary policy further, magnifying the downward pressure on the Pound.

For more, listen in to tomorrow’s webinar hosted by DailyFX’s Nick Cawley at 1130 GMT: UK Markets Look Ahead – Will GBP Dance to Brexit’s Tune Again?

However, there is one other event that will become more important in the days to come: the UK budget on November 22. The budget is a major set-piece event in the UK and it is possible that Chancellor of the Exchequer Philip Hammond will decide to ease fiscal policy after years of austerity that have made the government less popular and arguably weakened economic growth.

Any major loosening of fiscal policy could make the bank more inclined to tighten monetary policy in response, however unlikely that now seems after the bank’s “dovish hike”.

Politics more generally could also influence the Pound given the current weakness of Prime Minister Theresa May’s position as head of a party without a majority in the House of Commons. While the markets traditionally favor her Conservative Party over the opposition Labour Party, they might welcome a general election if it was thought likely that would result in a stronger government.

Chart: GBP/USD Five-Minute Timeframe (November 2, 2017)

Brexit Briefing: Brexit to Drive GBP Now UK Rates Have Risen

Chart by IG

Markets

Brexit Briefing: Brexit to Drive GBP Now UK Rates Have Risen

Upcoming UK/EU Event Risk (November 3, 2017, All Times GMT)

Brexit Briefing: Brexit to Drive GBP Now UK Rates Have Risen

--- Written by Martin Essex, Analyst and Editor

To contact Martin, email him at martin.essex@ig.com

Follow Martin on Twitter @MartinSEssex

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