The British pound faced headwinds going into the weekend after weaker than expected consumer data revealed UK retail sales had fallen again in October, as consumers expressed worry for the year ahead with prices and Covid-19 cases on the rise.
However, preliminary PMI data for October came in stronger than expected, which settled market nerves and helped the British Pound recover from a slight dip.
The pound to euro exchange rate went from 1.1870 on Friday morning, to a low of 1.1828 following the retail sales, before recovering to 1.1850 in the wake of the PMI numbers. While the pound to dollar exchange rate went from 1.38 to a low of 1.3770 before recovering to 1.38.
It comes as the BoE’s new chief economist, Huw Pill, said inflation in Britain could surpass a “very uncomfortable” 5%, and the question of whether to raise interest rates would be a “live” one at its 4 November meeting, the Financial Times reported.
Investors said that it makes the pound vulnerable should the BoE disappoint expectations.
“I would not be shocked – let’s put it that way – if we see an inflation print close to or above 5% [in the months ahead]. And that’s a very uncomfortable place for a central bank with an inflation target of 2% to be,” Pill told the FT.
Meanwhile a record proportion of the British public thinks inflation will accelerate, according to data also released on Friday.
Some 48% of people surveyed this month by consumer research firm GfK expected prices to increase more rapidly over the next 12 months, up from 34% in September.
Bank of England re-pricing
Economic and financial analysts at ING said in a press release sent to Capital.com that they expected some subtle warnings from the Bank of England’s November policy meeting.
“If financial markets are right, UK interest rates will have hit 1% by next summer. That would take the bank rate to the highest level since before the global financial crisis. And that’s on top of the Bank of England’s planned move to shrink its balance sheet when rates hit 0.5%.
“Economists are fairly united now that these market expectations are overdone. Unusually this pricing implies that the BoE will need to do more than the Fed to tackle rising inflation - something we think isn’t justified. Our own view is that, beyond an initial rate hike in November, the subsequent tightening process is likely to be much more gradual than investors are currently pricing.
“But picking out the catalyst for a rethink in financial markets is less straightforward. It may take some time for a correction to materialise,” ING said.
The company also said the path for GBP rates most consistent with its macro view is a re-steepening of the curve – due to lower rate hike discount at the front-end, but also reflecting more accurately the shortfall in gilt demand stemming from the BoE balance sheet reduction.
“A re-pricing of the BoE cycle on the back of a very split vote to hike on 4th November or on some form of rate protest in the BoE’s three year CPI profile (2024 forecast below 2%) could trigger a knee-jerk sell-off in the pound.,” ING also warned.
It added that the day risk volatility priced in the FX options market suggested that sell-off could drive EUR/GBP some 40 pips higher on the day.
“Yet we doubt this will turn the near term bullish trend for GBP,” it noted. “The fact that the BoE has set its tightening stall out (like fellow G10 central bankers in Norway and New Zealand) suggests it is very hard to play the top in UK rates and the pound,” it said.
ING also highlighted that currencies, typically, perform well at the start of tightening cycles. “Unless the BoE can convince markets of some kind of ‘one and done’ or ‘two and done’ when it comes to tightening, we think GBP finds support on any BoE-day disappointment,” ING added.