The pound weakened against many of its major currency counterparts on the interbank market this week, although it’s recovered some ground overnight. In part, this is because several members of the Bank of England’s (BoE) nine-person Monetary Policy Committee (MPC) have all made remarks, saying that they could vote to cut UK interest rates soon, although the markets aren’t yet sure they’ll do so.
According to the Central Bank, an interest rate cut would be made to support the UK economy, given the continuing uncertainty over the UK’s future trade talks with the EU and Brexit, and falling Gross Domestic Product (GDP) growth and inflation. Following the policymakers’ remarks, financial markets have lifted the odds that the BoE will ease monetary policy up to 62%, from 5% at the start of this year.
In particular, since Thursday 9th January, four members of the UK Central Bank’s MPC have suggested that they could cut interest rates. For example, last week Governor Mark Carney told a BoE Research Workshop that, if UK economic growth doesn’t accelerate, it could trigger a “relatively prompt response” from the Central Bank. Mr. Carney’s colleagues Silvana Tenreyro and Gertjan Vlieghe later echoed his remarks.
Meanwhile, this week MPC member Michael Saunders told a college in Northern Ireland that "it probably will be appropriate to maintain an expansionary monetary policy stance and possibly to cut rates further, in order to reduce risks of a sustained undershoot of the 2% inflation target."
In addition, the BoE also looks likelier to cut interest rates, because this week we’ve learnt that UK inflation fell further in December. According to the Office for National Statistics, UK price pressures fell by 0.2% last month, to 1.3%. This is the lowest in three years, and further below the UK Central Bank’s official target of 2.0%.
In general, lower inflation points to a sluggish economy, because businesses don’t feel confident enough about customers’ demand to raise prices. This could in turn encourage the BoE to cut interest rates, thereby weakening GBP.
However, it’s not a sure thing that the BoE will cut interest rates later this month which has played a part in sterling’s slight overnight rebound. In particular, if the UK economy shows signs of strengthening in the next fortnight, the Central Bank could decide to keep interest rates steady.
For example, a recent Institute of Directors survey has found that, at the end of December, firms were their most confident about the outlook for the next year than any time since the survey started in January 2018.
We’ll learn more about the growth of the UK economy when the January Purchasing Managers Indices are released on Friday 24th. These could be worth watching, for their effect on sterling.
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