Marius Paun | London, UK | Senior dealer | Thursday, 18th June 2020
Earlier today, the Bank of England announced it is expanding its bond-buying programme, also known as quantitative easing, by a further £100 billion to boost the UK economy, hit by the worst recession in 300 years. The vote was 8-1 in favour. Matching the projections, the decision will take the total programme from $645 billion to £745 billion. At the same time, the UK central bank kept its benchmark interest rate at 0.1%, a record low, as was widely anticipated.
At the previous meeting, two members of the committee had already voted for a 100 billion pound expansion in asset purchases. It indicates that Bank of England members have shifted their stance in the recent weeks becoming more open to further monetary easing. There was also an increasing number of members declaring they aren’t ruling out pushing interest rates into negative territory. However, markets are confident that easing efforts from central banks and governments around the world will aid in offsetting the negative economic impacts of the coronavirus.
In reaction, the GBPUSD fell from an intraday high of 1.2562 to 1.2427 at the time of writing. It seems the pound remains under pressure after last week’s sharp selloff on the back of a pessimist outlook from then US Federal Reserve coupled with concerns over a second wave in the coronavirus pandemic. That sparked support for the US dollar who received an additional boost after the release of the Retail Sales report for May showing an increase of 17.7% month on month. It was the best jump ever recorded, far surpassing analysts’ expectations which called for ‘only’ 7.7% growth.
Meanwhile in the UK, the inflation data for May was 0.5% year on year, fully in line with market consensus. Core inflation was 1.2% year on year which proved softer than expected. It is understandable as the consequences of Covid-19 still put plenty of downside pressure on consumer spending and economic activity in general. Although most of Europe has reopened as infections rate are continuing to drop (in some parts significantly) it is not the same picture in other parts of the world.
In Latin America and southern United States, the number of coronavirus cases continue to rise rapidly, which could keep the greenback strong and in turn maintain the downward pressure on the GBPUSD. On the other hand, reports of additional fiscal stimulus in the US, including the $1 trillion infrastructure project has helped the equity markets turn around on Monday. In response the US dollar gave back some of its previous gains thus supporting the GBPUSD.
Given the heightened speculation about negative rates becoming even more widespread, we can have a look at the subject. Interest rates have been negative in Japan for years now, Switzerland, Denmark and some parts of eurozone. Interestingly Sweden had negative rates for 5 years but ended the policy in 2019 as ‘it did not work’. And now, because of the recession brought by coronavirus the UK and the US are beginning to entertain the idea. Despite the opposition from Fed Chair Jerome Powell, President Donald Trump has called for them for months.
But why would central banks employ negative interest rates? in theory, they would push investors holding cash to get back in the game and take more risk in the hope of getting a decent return. At the same time, it could persuade borrowers to take on even more debt (at next to nothing costs) which in turn should give economic activity a boost exactly it needs it most.
However, if the banks start charging savers money for holding cash in deposit accounts, savers could just pull the funds out and keep it in a safe deposit box (assuming the mattress is not spacious enough …. for the rich ones). In addition, there could be the psychological struggle, how could the retail investor be convinced to lend money to the bank and then expect to get back less later on? So negative rates between commercial banks and central banks is one issue but could get a lot trickier between investors and commercial banks, let alone the disastrous effect it could have on the pound sterling.
GBPUSD has recovered from the lows of 1.1409 reached on 19th of March and for the past two and a half months has been in a sideways range between 1.2074 and 1.2812. The moving averages seem to be about to cross again but as we mentioned before those signals are not very reliable in a consolidation trend.
On the upside a rally-back above 1.2637 will indicate the bulls are not yet ready to give up, as the last few weeks would make you believe. That level needs to be confirmed first. Buyers could be looking at 1.2750 as the next resistance target followed by 1.2812. A breach above the latter would shift the medium-term trend to bullish albeit at a steady pace. On the downside, the immediate target is at 1.2343 which shifted quite a few times between support and resistance in the last few months so likely to be on the radar. That will open the way for support around 1.2150 followed by the aforementioned 1.2074 which would mean bears have re-established control.