Sterling & Bank of England take stock after monetary and fiscal easing…
Last week was one of, if not, the most eventful week in the long history of the pound sterling. The most dramatic headlines came from the GBPUSD pair, which reached its lowest levels since 1985 after a spectacular 13.5% plunge measured from highs on the 9th of March to Friday’s lows. Although GBPUSD remains close to last week’s lows as of the time of writing, sterling has managed a modest rally against the euro.
Looking ahead, the UK’s status as a small open economy with a large current account deficit means the pound will remain vulnerable to further depreciation, during periods of intense risk aversion and stress on dollar funding. A likely expansion in the fiscal deficit due to last week’s historic economic package from the Treasury will also add to these fundamental drivers for sterling weakness.
As significant as last week’s price action was, the policy response from the Bank of England and UK treasury was even more seismic:
- At a special meeting on Thursday 19th March amid high volatility UK and global markets, the BoE announced a re-start of quantitative easing worth £200bn, cut bank rates to 0.1%, and enhanced its Term Lending Scheme. These measures were followed by a Covid Corporate Financing Facility in cooperation with the Treasury, which is aimed at providing emergency liquidity to corporates via purchases of corporate paper.
- Rishi Sunak announced a sweeping stimulus package on Friday 20th March that included an unprecedented pledge to pay 80% of inactive workers’ salaries. This is likely to cost around £3.5 billion per 3 months and impact 1 million workers. Other direct spending measures bought the total direct fiscal stimulus including previously announced Budget spending to £32 billion.
The combined fiscal and monetary response from the UK is both cutting edge and timely and is likely to be studied in textbooks for decades to come. As far as mitigating the economic impact of the coronavirus, it is likely to be a “best in class” solution in terms of scope and timeliness. However, two important unknowns remain for sterling: what baseline the government’s measures will be acting on, and how markets will trade UK assets, especially gilts and sterling. Given the UK has only just implemented the social distancing measures that limited the spread of Coronavirus in places like Italy and South Korea, the local outbreak has the potential to be particularly bad. Income outbreak data, therefore, has the potential to weigh further on sterling.
Market conditions for sovereign debt and demand for dollar funding are two additional sources of uncertainty for sterling.
The Bank of England was explicit in saying that its dramatic intervention on Thursday was prompted by volatility in gilt markets; which saw yields spike suddenly during the first half of the week. Although aggressive easing measures from the BoE, ECB, Fed, and others seem to have calmed sovereign markets, for now, further panic events could easily see a repeat of last week’s panic. The BoE’s statement last week contained an extraordinary comment about potential participation in primary gilt markets. This would essentially see the Bank of England purchase gilts directly from the Government, in outright monetary financing. If such action is necessary during a period of market panic, further sharp falls in sterling of the scale seen recently would be possible, potentially taking EURGBP to parity and beyond.
These possibilities, as well as more details on the BoE’s potential future options for easing, are likely to be discussed further on Thursday’s MPC meeting. No press conference is currently officially scheduled, although one may be announced closer to Thursday.
Author: Ranko Berich, Head of Market Analysis