The Pound Sterling (GBP) attempts a recovery move as investors start digesting the upside risks of the global economic slowdown, while the absence of supportive fundamentals keeps the overall trend wobbly. The GBP/USD pair could resume the downside journey as the tight interest rate policy by the Bank of England (BoE) has dampened the labor demand outlook and has exposed the economy to a possible recession.
The UK economy shrank in July due to a sheer decline in service sector output as persistent inflation narrowed households’ pockets. Inflation risks are skewed to the upside as wage growth remains strong. The Pound Sterling is expected to deliver a bumpy ride as investors shift focus to the Consumer Price Index (CPI) data for August, which will be released next Wednesday. The inflation data will be followed by the interest rate decision from the BoE, which will be announced next Friday.
Pound Sterling rebounds after discovering a cushion near 1.2400 as the risk-aversion theme eases. The recovery move in the Cable is backed by a sell-off in the US Dollar. The absence of supportive fundamentals could fade and invite investors to use the pullback move as a selling opportunity. The asset seems settled below the 200-day Exponential Moving Average (EMA), which trades around 1.2480.
The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).
When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.
In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.
Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.
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