Interest rate hikes are expected to support the pound's continuous rise, why are investment behaviors still bearish?

On Friday (October 1), supported by the expectation of the central bank to raise interest rates, the pound rose against the dollar for the second consecutive trading day, but it still fell by more than 1% this week. Under the impact of soaring energy prices, declining business confidence and the end of the government’s vacation plan, the pound against the dollar this week fell to its lowest point this year and suffered the most violent volatility since March. Some analysts believe that the positive interest rate hike may not be able to support the pound's rise for a long time.

JPMorgan Chase expects the Bank of England to raise interest rates this year if supply problems continue

Allan Monks, an economist at JPMorgan Chase & Co., said that although the Monetary Policy Committee tends to postpone interest rate hikes until 2022 to avoid panic, the epidemic and Brexit will have an impact on employment recovery. The negative impact may extend to longer-term prospects or will force the Bank of England to take action earlier.

In the minutes of the September meeting, the Bank of England opened the door to raise interest rates as soon as November, saying that any future tightening measures should begin with a rate hike. It is difficult for analysts to grasp what information will affect the prospects for the central bank to raise interest rates. Monks said news about wages, the rate of labor market contraction and inflation expectations will have a major impact. .

If the government subsidy program that ends on September 30 fails to ease the pressure on the labor market, then tightening in the fourth quarter of this year looks more likely.” The previous basic expectation of JP Morgan Chase was to raise 15 basis points in the first quarter of 2022. Then increase by 25 basis points in the third quarter.

With the rising risk of inflation, the market is currently digesting the price of three interest rate hikes next year, betting that policymakers will be more worried about soaring inflation rather than an uncertain economic recovery.

The Governor of the Bank of England Bailey has said that if necessary, all members of the Monetary Policy Committee are prepared to raise interest rates before the end of the year to prevent inflation from continuing to rise, but there are still a series of views on how the economy will develop. According to surveys, the new chief economist Huw Pill may be hawkish, while Catherine Mann, who joined the interest rate setting committee in September, has a more moderate attitude.

Multiple negatives hit investor sentiment and put pressure on pound

Over the past six months, the pound has fallen by 2.3%, underperforming all other G10 currencies except the Australian dollar. Option traders are losing confidence, and the one-month risk reversal indicator that measures market positions is close to the most pessimistic level in six months. At the same time, the pound's hedging cost in the coming week is close to the highest level since March.

Investor sentiment has been hit by a new complex situation triggered by Brexit, rising wages, and a possible national insurance tax hike next year. Anne Beaudu, asset manager of Amundi UK Ltd, said, "This is not just a problem with the Bank of England, it is more about the consequences of Brexit."

This week, the tensions caused by the fisheries issue intensified, and France accused the United Kingdom of violating the Brexit agreement, which may further affect market sentiment. British business optimism towards the economy is the lowest since the winter lockdown, and business confidence plummeted in September. The attractiveness of the optimistic signs of the British economy is weakening. After the release of stronger-than-expected gross domestic product (GDP) data, the pound has rebounded, but it has not broken away from the low point of the year.


(The British pound fluctuates against the U.S. dollar a week)

At the same time, the two-year British government bond yield, which is most sensitive to interest rate hike expectations, climbed to 0.47% this week, the highest level since March 2020. This week, traders expect the Bank of England to raise interest rates by 65 basis points in 2022, which will raise the Bank of England’s key interest rate to 0.75% in December next year.

Jane Foley, head of foreign exchange strategy at Rabobank, said: “The prospect of the Bank of England tightening monetary policy may be seen as a policy error. Negative fundamentals in the UK have created a rift between the pound and interest rates.”


(Pound sterling and British government bond yield trends diverge)

Although the Bank of England is expected to raise interest rates, the pound may still fall further

Boosted by market expectations of the Bank of England’s early interest rate hike, the yield on the two-year British government bond climbed this week to the highest level since the beginning of the epidemic. However, although the pound rebounded, it was still near the low point of the year and suffered. The sharpest volatility since March. This sign shows that soaring energy prices, declining business confidence and the end of government vacation programs have outweighed the boost brought by the outlook for hawkish monetary policy. With the encounter of high inflation and low growth, there has been a difference in the yields of the British pound and the British government bonds.

Strategists at Nomura International Plc believe that there are enough reasons to be bearish on the pound, and they expect the pound to fall from around the current 1.35 level to $1.3150 next month, the lowest level since December last year.

Jordan Rochester of Nomura Securities said: “The Bank of England’s conventional practice of raising interest rates equal to the strengthening of the pound will not happen. We have turned to pay more attention to inflation expectations. At the same time, the Bank of England’s decision-making expectations have been largely absorbed by the market.”


(Pound against the U.S. dollar daily chart)

GMT+8 At 21:26 on October 1, the pound was quoted at 1.3560/62 against the U.S. dollar