With the recession in the UK economy in full swing and the Bank of England scheduled to cut interest rates this week, further weakness in the British pound was expected. However not many people could have anticipated the degree of the sell-off that we saw in the British pound today.
The currency fell 3 percent or close to 500 pips against the US dollar, 2.8 percent (230 pips) against the Euro and a whopping 5.4 percent (800 pips) against the Japanese Yen. This price action indicates that the latest pieces of UK economic data suggest that the economy may be in weaker state than everyone initially anticipated.
The Bank of England has a tough decision ahead of them and a full percentage point rate cut is the minimum that we expect on Thursday.
The contraction in the UK manufacturing sector continues with the purchasing managers’ index falling to a record low of 34.4 in the month of November. Not only was the index much weaker than expected, but the new orders component also slipped to a record low. The deterioration in business confidence amid the mild improvements in consumer confidence suggests that consumers may not be translating their less pessimistic attitude into stronger spending. Mortgage approvals also fell to the lowest level in 9 years as the credit markets remain tight.
Bank of England Governor King has previously said that the single most challenging task at hand is to get credit to flow into the economy again. This is one of the main reasons why the central bank has been very aggressive in recent weeks. If the BoE still believes that over-delivering is the right solution, then we could see a bigger move on Thursday. Even if rates are only cut by 100bp, the next rate cut will certainly not be their last. While the Monetary Policy Meeting of December 4th will likely see rates decline to 2.00 percent, interest rates may not hit a bottom until 1.00 percent.
Talk of UK Adopting the Euro is Ridiculous
There was also talk of the UK adopting the Euro today which I think is ridiculous. The European Commission made a poorly timed statement reintroducing the notion that the UK should submit to joining the Euro-zone. The UK has denied any intentions to do so and the EC’s reasoning seems inconclusive in the fact that a unified Europe would promote efficiencies that would single-handedly thwart off a recession. When considering the ECB is largely recognized as being behind-the-curve in the rate cut arena, such an arrangement would result in unforeseen challenges for the UK. The BoE has not sat idly by waiting for destructive forces to consume them; in fact they have been one of the most aggressive proponents in the fight for reducing target interest rates. The central bank seems fully capable to sustain itself entirely on internal resources. A joint EZ – UK alliance would probably create more problems than solutions for the UK economy.
Technically, the GBP/USD is attempting to enter the sell zone, which I determine using Bollinger Bands. If the currency pair manages to break 1.4800, we could see a move down to the 6 year low of 1.4558.