The Pound Sterling (GBP) remains on the backfoot as investors continue to dump risk-perceived assets as the market mood turns cautious. The GBP/USD pair may continue to remain on the tenterhooks as risks of a recession in the United Kingdom have increased due to vulnerable economic prospects. The UK’s Manufacturing and Services PMI, which gauge the health of both sectors, have fallen into contraction territory, while strong labor demand appears to be fading.
The UK economy is seen losing strength amid uncertainty over the interest rate outlook ahead of the general elections. UK Prime Minister Rishi Sunak promised to halve inflation to around 5.3% by year-end, but the pause announced by BoE policymakers signals that the Prime Minister may fail to keep the word. For further action, investors will focus on the final S&P Global Manufacturing and Services PMI, which will be released next week.
Pound Sterling looks set to continue its losing spell for a seventh trading session as investors move to safe-haven assets. The GBP/USD pair refreshes a six-month low at 1.2110 and is expected to test the round-level support of 1.2100. The downside spell in the GBP/USD pair could continue to the psychological support of 1.2000 as the 200-day Exponential Moving Average (EMA) starts declining. Momentum indicators continue to trade in the bearish territory, warranting more downside for the pair.
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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