The Pound Sterling Under Pressure

Marius Paun | London, UK | Senior dealer | Thursday, 01st October 2020

After reaching a recent high of 1.3481 against the US dollar on September 1st, the pound sterling has been on a downward slope. A few reasons have been highlighted as the drivers: fears of a second wave of coronavirus, the never-ending saga involving the UK exit from European Union and to spice up the mix, some comments from Bank of England raising investors’ eyes brows.

Let’s consider these in turn. First of all, what are the odds of a second national lockdown? A few months back government officials refused to rule it out even if Prime Minister Boris Johnson appeared to discard it. Last month the Chief Medical Officer for England Chriss Whitty said the rate of infections has been growing rapidly and over 80% of doctors in England expect a second wave within the next six months. It’s true there were regional second lockdowns but not at a national level, probably because the country cannot afford it. Already the National Institute of Research in Economics, Britain’s oldest, had a grim prediction, it will cost the country £800 billion and unemployment will hit over 10% this year.

Chancellor Rishi Sunak has come up with a new wage subsidy scheme but added that is impossible to know exactly how the labour market will look like in the UK, what business/ jobs will survive. Apparently, only employees ‘with viable jobs’ will be eligible meaning many will receive limited or no assistance at all. For the companies who will be able to take advantage of the new plan, the government will only replace two-thirds of the lost wages this time.

Recently, the UK government announced new restrictions in response to Covid-19 numbers picking up again. There’s a whole debate whether the numbers are the result of more tests being performed compared to March more than the infections spreading fast again. Many consider the measures as a bit of an overreaction. Anyhow, the new restrictions may not lead to a total lockdown but they resemble the ones introduced in spring. It’s hardly ‘back to normal’ when everyone is encouraged to work from home again if possible, pubs are meant to close at 10 pm and no more than six people can meet in a house.

The obvious challenge going forward will be jobs. It’s well known that the current furlough scheme where the government was paying at fist 80% and then going down to 60% of the wage bill is going to end this month. It will be replaced by a six months Job Supporting Scheme. Jobs will be subsidised for staff on reduced hours but only if they’re working a third of their usual. Employers will pay the wages for the actual hours. Both the government and the employer will then pay a third for the hours not worked with the rest foregone.

As a result, unemployment is anticipated to rise as some of the hardest-hit businesses will go under. It will also mean an increase in public spending. Capital Economics is predicting ‘the new measures could cost about £5 billion (0.2% of 2019 GDP). That places the total cost in the region of £200 billion or 8.9% of GDP. It will also mean that borrowing will go to 20% of GDP in 2020-2021.

Bank of England’s governor Andrew Bailey weighed in telling MPs the UK faces a permanent £33 billion annual hit to the economy due to coronavirus. What’s interesting though is the central bank view of pushing interest rates into negative territory. Financial Times already mentioned it as part of the sterling weakness lately. ‘Minutes from the latest decision to keep monetary policy on hold last Thursday show the BoE beginning to brief regulators on the possibility of unprecedented sub-zero rates should the outlook for inflation warrant it’.

Commercial banks rushed in to speculate that it is a signal that negative rates could be becoming a reality. Despite denying it a few days later, there is some consensus BoE might want to keep the idea fresh. One could be political, to show they’re not out of ammo, they can get creative when needed. Additionally, if more quantitative easing will be the only choice to fund the ballooning deficit and it seems we’re heading that way, the market will be prepared in advance, it will not come as a shock…. a bit like the frog in the boiling water experiment.

There’s also ‘the small matter of Britain exiting the European Union’ putting downward pressure on the pound. We learned from BBC ‘the EU has begun legal proceedings against the UK after it refused to ditch plans to override sections of the divorce deal’. European Commission President Ursula von der Leyen sent a letter to the UK government regarding concerns over the draft legislation and said Britain has until the end of November to respond.

The dispute could lead to a court case against the UK at the European Court of Justice. On the other hand, Prime Minister Boris Johnson commented that both sides should ‘move on’ if a deal is not reached by mid-October. Which side will cave in first? It is tempting to say they will find a way to agree at the very last minute but politically it could be a killer for the side who compromises the most, regardless how they will present it publicly (remember David Cameron?) only time will tell.

The Chart shows GBPUSD is still in an uptrend on the long term, downtrend on the medium trend and by and large sideways in short term. The short-term moving averages have turned higher again and appear to cross back above the longer-term ones.

On the downside, the immediate support is at 1.28 which held its ground in the past few sessions followed by 1.2760. If sellers manage to break below those levels, they will undoubtedly feel confident for a test at 1.2680. If that mark gives way, the short-term trend will shift to bearish. On the upside a rally-back above 1.3 will indicate the bulls are not yet ready to give up as the last month would make you believe. That level needs to be confirmed first. Buyers could be looking at 1.3060 as the next resistance target followed by 1.3140.