SVB FX Flash Update: British Pound (GBP)

Summary:

British pound fell again to approach its lowest levels of the year. Last Thursday and Friday, there was a panic sell-off in the GBP/USD. Triggered by the Bank of England’s decision not to hike interest rates as expected, the currency pair fell from $1.3700 to $1.3424, not quite as low as $1.3412 seen on September 30, but below January’s $1.3452. FX traders remain positioned long GBP but are seen actively buying downside protection via GBP put options. ¹

Bank of England’s dovish head fake. Last Thursday, the BoE decided not hike interest rates, catching traders totally off guard, as expectations were high that the BoE would hike its benchmark rate by 15 bps from 0.10% to 0.25%. Following the announcement, UK gilt yields collapsed – policy-sensitive two and five-year gilts by 20 points, the largest intraday moves in five years – as bond traders reeled in expectations for a sharp rise in rates next year. ²

PM Boris Johnson under fire. An article in this week’s The Economist describes how the British government went to “disgraceful lengths to protect a Tory member of parliament.” MP Owen Paterson broke rules repeatedly in lobbying for corporations for cash, and now the “Paterson affair” threatens to undermine trust in the Tory Party and PM Boris Johnson. ³ Shortly after the article was published, Owen Paterson announced his resignation as an MP, and on Monday, the British government apologized for the debacle. However, this scandal may have an extended shelf life.

G-10 CURRENCY PERFORMANCES NOVEMBER MTD

SVB FX, Bloomberg

Several themes are driving the value of the British pound:

• Bank of England is expected to hike rates in December. In the week leading up to the meeting, BoE speakers had been stressing the need to tighten policy to head off the risk of transitory inflation becoming more permanent. BoE members have also expressed concern about rising costs being passed on to consumers due to the “proportion of businesses reporting a surge in operation costs,” which soared to its highest level since records began in 1996. ⁴ Even after last week’s head fake, Bloomberg’s survey of economists puts the odds at 56% for a 15 bp BOE rate hike on December 16. ⁵

• UK economy is performing well despite weathering some of the highest COVID-19 cases in Europe and serious supply-chain disruptions. ⁶ The closely-watched UK Composite Purchasing Manager’s Index (PMI) in October rose unexpectedly to 57.8, its highest level in three months. The UK’s outsized Q2 GDP growth of 23.6% YoY was the best of every country we monitor, outside Peru’s 41.9%! GDP for Q3 will be released on November 11 and is expected to show respectable growth of 6.8%. ⁷

• COVID-19 cases are still high. According to healthline.com, the UK is still battling COVID-19. Cases rose sharply in late October, even as deaths were falling. ⁸ In a BBC News article last week, this latest surge is attributed to a premature easing of restrictions, students going back to school, a slow rollout of third jabs, and the UK’s “state of complacency” in both officials and households. ⁹ Fortunately, November’s COVID-19 cases are declining from October highs. ¹⁰

• Possible “Brexit Exit”? Tensions are rising again between the UK and EU over implementation of post-Brexit trading arrangements for Northern Ireland. The entire EU-UK Trade and Cooperation Agreement could be terminated if the UK makes good on its threats to activate Article 16, a safeguard clause which either side can trigger if they believe the arrangement has caused “serious economic, societal or environmental difficulties” or the “diversion of trade,” which the UK said has already been reached (!). ¹¹

• Currency traders are positioned long GBP but are buying protection from a possible sell-off. According to the CFTC’s COTS report, large currency speculators remain positioned net long GBP. But in the currency options market, there has been a significant increase in demand for GBP puts (for downside protection) over calls. ¹²

• TECHNICALS. Last Friday, GBP/USD bounced hard off the $1.3424 lows, rising to a high of $1.3607 this morning. However, GBP/USD remains well within a five-month downtrend, which will remain technically intact unless it breaks above its previous cycle high at $1.3835. Bloomberg’s latest survey of forecasters indicates a slight bullish bias – the average forecast for Q1 2022 is $1.37 and climbs to $1.40 by year-end. ¹³ We agree, basing our view on the underlying global recovery/reflation/dollar bear story for the coming year.

For more analysis on FX markets or information regarding SVB's FX services contact your SVB FX Advisor or the SVB FX Advisory Team at fxadvisors@svb.com.