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Sterling falls as Bank of England flags recession concerns

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6 May 2022

Written by
Matthew Ryan

Senior Market Analyst at Ebury, Chartered Financial Analyst. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

The pound collapsed below the 1.24 mark versus the US dollar on Thursday, its lowest level since mid-2020, after some more muddled communications from the Bank of England.

A
s expected, interest rates were raised by 25 basis points to 1%, the highest level since 2009. The bank’s monetary policy committee does, however, appear more divided on policy than we’ve seen in some time. The vote on interest rates was more hawkish than we had expected, with all nine members in support of an immediate hike – we thought that one or two of the more dovish members could have voted in favour of no change. In a surprise move, three of the nine members (Mann, Haskel and Saunders) were all in favour of a 50 basis point move higher in rates.

It’s accompanying communications were pretty mixed, and failed to provide market participants with much clarity. The bank’s inflation assessment was upgraded in light of rising global commodity prices. Headline inflation is now set to peak in excess of 10% later this year, with the 1-year inflation forecast raised to 6.65% from 5.2%. Governor Andrew Bailey also said that the UK labour market was very tight, and the bank’s year-end forecast for wage growth was increased to 5.75% from the 3.75% expected in February. While all of the above warrants an aggressive pace of tightening, the MPC appears growingly concerned about the impact of rising commodity prices on the UK economy. Bailey said that inflationary pressures had intensified, and that Russia’s invasion of Ukraine had led to a material downturn in the growth outlook globally.

The BoE kept its 2022 growth forecast unchanged, although it now expects activity to contract by 0.5% in 2023 (down from the +1.5% expansion pencilled in previously). It also tweaked its wording on future policy moves, although its forward guidance all remains very vague and pretty muddled, suggesting to us that policymakers are unsure on upcoming policy moves ahead of a potentially damaging period of ‘stagflation’. Sterling reacted to the bank’s lack of clarity, and indeed the threat of a UK recession, in an unsurprisingly negative fashion, ending London trading not too far above the 1.23 mark on the dollar.

Figure 1: GBP/USD (05/05/2022)

Source: Refinitiv Date: 05/05/2022

Attention in markets today will quickly turn to this afternoon’s US nonfarm payrolls report. Investors are eyeing another strong payrolls number just shy of the 400k mark, with an upward revision to the March data likely, in our view, given the preliminary estimate has been revised higher in each of the past seven months. Below we outline the possible arguments in favour, and against, a strong payrolls number – we err on the side of the data perhaps missing expectations.

Arguments in favour of a weaker NFP number:

  1. ADP employment change number missed expectations (247k vs. 395k). Only third time in the last 8 months.
  2. Employment component of ISM services PMI has dropped to 49.5 from 54.0 (below level of 50 representing contraction).
  3. Employment component of ISM manufacturing PMI has decreased to 50.9 from 56.3.
  4. CB consumer confidence fell to 107.3 in April from 107.6.
  5. Rise in Challenger job cuts (24.3k vs. 21.4k) – the most in 11 months.

Arguments in favour of a stronger NFP number:

  1. 4-week moving average of initial jobless claims remainder lower in April than most of March (178k vs. 198k at start of March).
  2. Continuing jobless claims declined to a 50-year low 1.38 million in third week of April
  3. ADP employment change number an increasingly unreliable barometer of NFP.

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