Further improvement in the UK’s labour market helped stocks bounce on Tuesday, but sterling remained mired at a 12-month low against the dollar as investors continued to wind down bets on the Bank of England raising interest rates on Wednesday.
Three weeks ago, markets were pricing in the near-certainty that the Bank of England will raise the main bank rate on Thursday from 0.1% to 0.25% after it declined to do so at the November monetary policy meeting.
Now, it appears money markets are only pricing in around a 15% chance the Bank will pull the trigger in two day’s time.
“The Committee showed in November that it’s comfortable with waiting for more data – and we aren’t going to know for sure what Omicron means for the UK recovery for a least a couple more weeks,” said James Smith, developed markets economist at ING.
As a safeguard against the rapid spread of the Omicron coronavirus variant across the UK, Prime Minister Boris Johnson introduced measures last week that included a work from home advisory and proof of vaccination for entry into certain venues, as well as mandatory mask wearing in many public indoor settings and on public transport.
Then, on Sunday, the PM issued a stark warning about the “tidal wave of Omicron” and said that the government’s response would be to offer all adults a vaccine booster before Christmas.
Sterling fell 0.4% against the dollar on Monday and, on Tuesday, remained just a few pips above its lowest point for a year versus the US currency, as markets prepare for an onslaught of data and major central bank decisions this week.
“With the number of Omicron infections being driven up by what Prime Minister Boris Johnson has described as the ‘remorseless logic’ of exponential growth, the chances of a UK interest rate rise this week are heading in the exact opposite direction,” said Jay Mawji, director of global liquidity provider IXPrime.
On Wednesday – a day ahead of the BoE decision – monthly consumer price index (CPI) data are published and expected to show annual headline inflation rose to 4.7% in November from 4.2% in October. The bank now expects headline CPI to breach the 5% level in April next year after utility price caps are raised.
“Even though there’s a strong chance that Wednesday’s inflation data will be a blowout, the Bank is now almost certain to ignore it and delay a rate rise once again,” said Mawji. He concluded: “With the odds of a December interest rate rise now looking longer than those of a White Christmas, sterling is swooning.”
Should the latest Covid restrictions imposed by the government last week begin to show signs of slowing the economy, the Bank could plausibly wait longer to begin its rate increases. Markets reacted negatively to the measures on expectations economic growth will slow in the coming months.
“We are concerned that the rhetoric from some in government risks instilling a lockdown mentality when in actual fact the proposed measures are far short of that,” said Tony Danker, director-general of the Confederation of British Industry.
He added, with reference to the government’s work from home advisory: “Some economic activity is displaced to local areas, but it also leaves our town and city centres under real strain for retailers and hospitality. WFH in practice meaningfully restricts trade for some businesses and impacts mental health too.”
Federal Reserve hawks
Sterling’s year low against the dollar comes as the US Federal Reserve’s open market committee (FOMC) meets on Wednesday to decide on policy.
Having dropped the “transitory” inflation theme, the Fed now appears to be on a more hawkish setting and some are expecting the central bank to speed up the pace of tapering its asset purchases so that interest rates can begin to be raised sooner.
“We expect GBP/USD downside risks to be larger, and when combined with a USD-positive outcome of Wednesday’s FOMC meeting, we could see cable trade within the $1.30-1.31 range by the end of the week,” said Francesco Pesole, FX strategist at ING.
UK economic malaise
Jane Foley, senior FX strategist at Rabobank, also suggests sterling’s weakness was already deep set given the evidence of slowing UK growth in recent months from PMI surveys and retail sales data, and that further restrictive measures will underpin the malaise.
“The data heighten concerns about the momentum of the UK economic recovery, particularly in light of the new restrictions,” Foley said.
She added: “In our view, sterling’s performance in recent months is suggestive of a broader malaise among GBP investors which can likely be explained by concerns over headwinds to UK growth and a lack of reassurances about the post-Brexit UK economic outlook.”