British Pound Keeps Falling as Investors Bet on a Bottom

The Bank of England and politics could push the pound sterling even lower.
By Antonia Oprita ,

Editor's Note: This article was originally published on Real Money at 9:54 a.m. on July 13.

What's happening with the pound?

It started the day strongly in the green, jumping by 0.7% vs. the dollar, only to give back those gains and then some, to trade down 0.2% on the session. In this brave new world -- post-Brexit referendum -- perhaps investors should get used to this volatility.

The pound's fall might have a lot to do with tomorrow's Bank of England Monetary Policy Committee meeting. The market is pricing in an 80% chance that the MPC will cut rates by a quarter of a percentage point to 0.25%, after BoE governor Mark Carney's dovish statement immediately after the vote hinting at the rate cut.

The pound's reversal into weakness today could be explained by investors looking for even more dovish signals than that.

"One 25-basis-points cut is unlikely to turn the economy around and prevent a likely technical recession in the first half of 2017," said James Knightley, senior economist at ING. He expects the central bank to increase its quantitative easing significantly, by 125 billion pounds ($165 billion), taking the total to 500 billion pounds, starting with the bank's August meeting.

Knightley also expects the Bank of England's interest rate to end the year at 0%, and the Funding for Lending Scheme, which was launched in 2012 to offer cheap funds to banks on the condition they lend them on to the real economy, to be restarted after it had been gradually tapered off at the end of last year.

Beyond what the Bank of England will or will not do, the pound has been buoyed by the swift appointment of a new Prime Minister in the U.K., instead of weeks of political bickering.

But Home Secretary Theresa May, who takes over today from outgoing Prime Minister David Cameron, has her work cut out for her. She faces at least six big challenges before the markets can even remotely feel reassured that the U.K. is on a sustainable Brexit path.

Forecasts for the pound's exchange rate vary wildly, as market participants can find no consensus on what is likely to happen. Knightley said a dovish Bank of England and a quarter-percentage-point rate cut should send the pound back towards $1.29.

At Societe Generale, foreign exchange analyst Kit Juckes pointed out that the sterling short-squeeze could still go on for a while. He calculated that, since the peak before the E.U. referendum result was $1.5020 and the low since then was just above $1.28, a 50% retracement of the pound's fall would be around $1.39.

But his colleague Alain Bokobza, head of global asset allocation strategy, noted that "nobody argued against the view that $1.20/$1.25 is the next target."

Politics can only act as a tailwind for the pound so far, before turning into a cold headwind blowing in from the European continent. Beyond Theresa May being seen as a safe pair of hands, there aren't many reasons to be optimistic about the politics of Brexit.

Donald Tusk, the president of the influential European Union Council, said today that the E.U. cannot allow the U.K. to profit from leaving the E.U., as this would inspire others to follow suit, the BBC reported, quoting an interview Tusk gave to a Polish newspaper.

"No one should be seething with desire to punish, humiliate [the British] for what they have done to us. We cannot push them away from us, but we cannot let them profit from Brexit, as that would be lethal for the E.U.," Tusk said, according to the BBC.

Clearly, there may be a while yet before investors can confidently call a bottom for the pound.

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