Pound Sterling extends downside as Middle East conflicts dampen market mood

Pound Sterling faces an intense sell-off due to risk-off impulse and weak manufacturing activity data.
Persistent US inflation dampens the market mood.
The BoE is expected to keep interest rates unchanged for the second time in a row.

The Pound Sterling (GBP) dropped from a two-week high as the United Kingdom’s economic outlook weakened after factory output contracted for the second consecutive month. The GBP/USD pair surrendered the majority of recent gains as data from the US showed inflation remains persistent, denting the risk appetite of market participants. UK’s manufacturing and overall Industrial Production dropped in August as firms cut spending on labor and inventory due to a poor demand outlook.

More sell-off in the Pound Sterling is anticipated as Bank of England (BoE) policymaker Swati Dhingra supported a rate cut if economic growth remains below estimates. The UK is expected to remain on the backfoot compared with other G7 economies as it is struggling with higher interest rates, filthy trade relations with the European Union, and rising gasoline prices.

Regarding interest rate outlook, BoE Governor Andrew Bailey cited on Friday that the policy will remain sufficiently restrictive. The central bank is observing progress in inflation but there is still work left to do.

Daily Digest Market Movers: Pound Sterling slips as market mood sours

Pound Sterling resumes a downside journey as UK factory activity contracted for the second month in a row.
UK firms reported a decline in manufacturing activity in August amid a bleak demand outlook in the domestic and overseas market.
Monthly Industrial Production in August contracted at a higher pace of 0.7%, while investors forecasted a 0.2% decline. In the same period, Manufacturing Production decreased by 0.8%, double the expectations of a 0.4% drop.
On an annual basis, Industrial Production increased 1.3%, below the estimates of 1.7% but higher than the former reading of 1%. The Manufacturing Production rose 2.8%, lower than expectations and July’s reading of 3.4% and 3.1%, respectively.
While factory data remained weak, the monthly Gross Domestic Product (GDP) rose by 0.2% in August, as expected. In July, GDP contracted by 0.6%.
The absence of sufficient evidence that the UK economy could rebound may keep the Pound Sterling on the backfoot.
The UK economy is facing an economic shock, based on labor shortages, high interest rates, stubborn inflation, and poor trade relations with the European Union. This could force the Bank of England to keep interest rates unchanged for a second consecutive time in November.
In September, the BoE surprisingly paused the rate-tightening spell after 14 back-to-back interest rate hikes to 5.25%, a move that confirmed that policymakers are worried about the economic outlook.
According to the IMF forecasts, the UK will be the slowest-growing G7 nation next year.
On Wednesday, BoE policymaker Swati Dhingra favored a sooner rate cut if the growth rate declines beyond expectations. She further added that the UK economy has already ‘flatlined’, and that almost 25% of the impact from higher interest rates has already been absorbed by the economy.
After the UK factory activity data, investors will shift focus to the labor market data for August, which will be published on Tuesday.
The market mood turned cautious on Thursday after the United States headline inflation data for September turned out to be more persistent than expected.
Dampened market sentiment improved the appeal of the US Dollar. The US Dollar Index (DXY) discovered buying interest near 105.50 and recovered quickly to near 106.60.
Investors are expecting that the Federal Reserve (Fed) could end the year by elevating interest rates one more time by 25 basis points (bps) to 5.50%-5.75% as the progress in taming inflation towards 2% seems to have slowed down.

Technical Analysis: Pound Sterling drops to near 1.2150

Pound Sterling struggles for a firm footing as hot US headline inflation dampens market sentiment. The outlook for the GBP/USD pair weakens as it failed to sustain above the 20-day Exponential Moving Average (EMA) at 1.2258. The broader Cable bias is bearish as the 50-day and 200-day EMAs have already delivered a death cross.

BoE FAQs

What does the Bank of England do and how does it impact the Pound?

The Bank of England (BoE) decides monetary policy for the United Kingdom. Its primary goal is to achieve ‘price stability’, or a steady inflation rate of 2%. Its tool for achieving this is via the adjustment of base lending rates. The BoE sets the rate at which it lends to commercial banks and banks lend to each other, determining the level of interest rates in the economy overall. This also impacts the value of the Pound Sterling (GBP).

How does the Bank of England’s monetary policy influence Sterling?

When inflation is above the Bank of England’s target it responds by raising interest rates, making it more expensive for people and businesses to access credit. This is positive for the Pound Sterling because higher interest rates make the UK a more attractive place for global investors to park their money. When inflation falls below target, it is a sign economic growth is slowing, and the BoE will consider lowering interest rates to cheapen credit in the hope businesses will borrow to invest in growth-generating projects – a negative for the Pound Sterling.

What is Quantitative Easing (QE) and how does it affect the Pound?

In extreme situations, the Bank of England can enact a policy called Quantitative Easing (QE). QE is the process by which the BoE substantially increases the flow of credit in a stuck financial system. QE is a last resort policy when lowering interest rates will not achieve the necessary result. The process of QE involves the BoE printing money to buy assets – usually government or AAA-rated corporate bonds – from banks and other financial institutions. QE usually results in a weaker Pound Sterling.

What is Quantitative tightening (QT) and how does it affect the Pound Sterling?

Quantitative tightening (QT) is the reverse of QE, enacted when the economy is strengthening and inflation starts rising. Whilst in QE the Bank of England (BoE) purchases government and corporate bonds from financial institutions to encourage them to lend; in QT, the BoE stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive for the Pound Sterling.

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