The British pound fell significantly on Thursday following the policy decision from the Bank of England to leave interest rates unchanged at record low levels of 0.25%. The decision came in a vote of 6-2 in favor of leaving rates unchanged, with the two dissensions in favor of raising rates. At the previous policy meeting the vote had been 5-3 in favor of leaving rates unchanged, but Kristin Forbes, one of the members who voted in favor of raising rates, has since been replaced by the more dovish Silvana Tenreyro, who voted to stand pat on rates at this meeting. In response, the sterling touched as low as 90.485 pence per euro and was down over a cent against the U.S. dollar.
Although some economists had forecast that Chief Economist Andy Haldane may have voted to raise rates, most market participants had expected a 6-2 vote. The dramatic post-decision moves in the sterling came mostly due to the downward revisions in growth and inflation metrics released in tandem with the policy announcement. Economic growth projections for Britain in 2017 were reduced from 1.9% to 1.7%. Furthermore, in 2018 the growth projections were reduced to 1.6% from 1.7%. Also for 2018, expected wage growth was reduced to 3.0% from 3.5%. These significant reductions in growth and inflation metric expectations spooked the market into a sterling selloff.
The last thing the pound needs right now is further concern surrounding economic growth. The British economy and pound have both suffered since the Brexit vote and negotiations for the nation’s departure have not started out well. A great amount of political uncertainty has hovered over Britain since the surprising Brexit vote and has only grown since Theresa May’s failed attempt to consolidate power in early Parliamentary elections. Although the pound has recovered from its lows from Brexit, any signs of weakness in the economy or increased political tensions will quickly drag the currency lower.
The pound’s drop came as it was trading higher earlier in the day on the back of the services purchasing managers’ index (PMI) rising to 53.8 in July from 53.4 in June. The market had been expecting an increase to 53.6.
There exist two different tales for sterling this year when compared to the greenback and euro. The USD has dropped 6.42% this year against the pound despite the Fed raising rates twice and considering a potential third hike, though many market participants doubt the chances that the hike comes to fruition before the turn of the year. The majority of the rise in sterling has been a result of political uncertainty in the U.S. as doubts rise over the ability of the Trump administration to enact their pro-growth agenda. On the other hand, the pound is down 5.65% this year against the euro. Following mixed trading early in the year, the pound started to lose steam going into the Parliamentary elections and fell further after the debilitating blow to Theresa May.
Going forward the Bank of England will still be important for the pound. Although chances of a rate hike in the near future in Britain have diminished, there is always the chance that data improves and the hike comes back on the table. More importantly, however, are political and economic factors for sterling’s performance against the dollar and euro. U.S. economic data, especially regarding wage growth and overall inflation, will dictate if the Fed moves for a third time before year end. The ability of the Trump administration to salvage parts of its agenda, such as tax reform or financial deregulation, will play a large part in the strength of the dollar and overall American economic performance. Whether or not the tone of Brexit negotiations improves will greatly impact the sterling’s performance against the euro. The smoother the transition out of the European Union, the less pain the pound will feel.
Given the dichotomy of overall economic landscapes facing the Eurozone versus Britain, it is likely for the euro to continue to strengthen against the pound. Any further hawkishness from the ECB will likely push the euro higher, as the central bank considers the winding down of its asset-purchasing program. As for the dollar, it may regain some of the ground lost earlier this year against the pound if inflation data picks up in the U.S. in the near term. However, over the course of the rest of the year, it will be a roller coaster as the greenback and pound whipsaw based upon whatever political uncertainty is driving the markets in both nations. Given how the markets have reacted so far this year, it’s going to be a bumpy ride.