Ahead of the Bank of England’s Super Thursday meeting, the first for 2020, some investors are expecting the Bank to cut interest rates, with markets gauging a 50/50 chance of a rate cut.

On Tuesday, the pound dropped, while UK government bonds rose higher, suggesting that some currency strategists are expecting the BoE to cut its benchmark rate to 0.5 percent, from 0.75 percent.

Some economists believe that rates will either be cut this week or at the next meeting of the Bank in late March since currently there are encouraging signs that the country’s private sector is growing.

 In the Financial Times, Andrew Harman, portfolio manager at First State Investments stated that “Data from the second half of 2019 shows the UK economy was soft, although the recent January 2020 PMIs suggests a modest pick-up in economic activity [after] the election.”

 

How is the pound going to respond?

The British Pound has increased against the majority of leading currencies the beginning of the week, but on Tuesday it dropped against the euro and dollar ahead of Thursday's key BoE rate decision.

George Vessey, currency strategist with Western Union said: "The British Pound remains elevated but is lacking upside traction as it failed to hold at multi-week highs against the Euro and U.S. Dollar last week. If the BoE does cut rates, given the slide in inflation and lacklustre GDP growth, we can expect to see the Pound sold off." Vassey has also added: "Leaving rates unchanged may not have such an impact on Sterling as it didn’t weaken much when the probability of a rate cut jumped to 72% at the start of last week. Recent positive CBI and PMI surveys may be enough to prevent a rate cut this month, but the focus will be on sustained positive data for any real advancement in GBP upside."

With the possibility of a rate cut remaining unclear, the pound could initially fall if the Bank chooses to move on with a cut. Whatever the decision is, the pound will possibly be volatile as the result will be unexpected.

As mentioned, there are a few reasons that have driven investors to believe that the Bank might cut interest rates. Earlier in January, speeches from the Monetary Policy Committee members demonstrated their inclination towards a rate cut, with former governor Mark Carney stating that a weakness in the pound and weak economic data could lead the bank to a rate cut decision.  Indeed, economic growth has slowed down towards the end of 2019, while inflation was at 1.3% in December, below the Bank's 2.0% target.

With high volatility predicted on Thursday, all nine members of the monetary policy committee could vote for a rate cut, considering global recession fears, Brexit uncertainty, UK economic slowdown and inflation pressures.

On the other hand, if the majority votes for the rates to remain unchanged, taking into account improved business sentiment, then the pound could possibly stay flat. Ingvild Borgen Gjerde, FI and FX analyst at DNB Bank ASA clarified: "Expectations of a rate cut have fallen somewhat... and the GBP has strengthened as a result. We expect a rate cut this week but see significant risk that the BoE will remain on hold. As markets are only pricing in a 50% probability, the GBP should weaken this week if our projection materialises."

Finally, if only a very small number of members votes for a cut, then the hawkish sentiment could send the pound higher. For some analysts, economic data is not seen from a negative point of view and instead suggests that a rate cut is simply not justified. Marc-André Fongern, Head of FX Research at MAF Global Forex, noted that "The most recent UK economic data does not provide any justification for a rate cut at the end of January. The market may, therefore, be correcting its overblown expectations regarding an easing of monetary policy. Britain's economy is currently torn between the impact of potentially complex EU-UK trade negotiations and a spirit of optimism.”

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