Posted by Rewan Tremethick on August 4th, 2016.
Pound exchange rates have dropped markedly after the Bank of England (BoE) surprised markets by announcing much stronger-than-expected monetary stimulus measures. The Monetary Policy Committee (MPC) unanimously agreed to cut interest rates to 0.25% – the lowest in the Bank’s 322-year history. This was expected by markets, but investors and analysts have largely been caught-off guard by the other measures announced today.
Chief amongst them is a resumption of the previously dormant quantitative easing programme, meaning that the BoE is going to digitally create new money to buy bonds from UK banks, improving their cash flows. The QE programme has been dormant up until now; the BoE previously purchased £375 billion of bonds and other assets and has been reinvesting the returns from these to keep stimulus consistent. Now, however, the Bank will buy an additional £60 billion in bonds, taking the total value of assets held to £435 billion.
On top of this, the BoE has set aside £10 billion to buy corporate bonds. This follows in the footsteps of the European Central Bank (ECB) which recently had to start buying corporate bonds under its QE programme because its demand for government and bank bonds was so high it was struggling to fill it. This will help UK companies who are ‘making a material contribution to the UK economy’ to finance themselves, helping to keep UK economic activity strong.
On top of this, the BoE have allocated £100 billion to create a fund that will help UK banks to lend to consumers. Lower interest rates squeeze bank profits, so the BoE fund will help banks lend more to consumers, boosting spending and therefore economic growth, while still remaining profitable. This ensures that the benefits of cutting interest rates will trickle down through all levels of the economy and have the desired impact.
The Pound has responded to the news by dropping across the board, evidencing the fact that markets weren’t expecting such extensive stimulus measures. The Pound has fallen -1% against the Euro (GBP EUR), -1.3% against the US Dollar (GBP USD) and the Canadian Dollar (GBP CAD) and -1.7% against the Australian Dollar (GBP AUD) and the New Zealand Dollar (GBP NZD).
However, it’s worth noting that before the BoE decision markets were holding record short positions on the Pound, with net short positions falling to -80%. This means that traders were ‘betting against the Pound’. Overseas traders do this by borrowing Pounds from a broker and selling them for their native currency. When the Pound then weakens, the traders buy the amount they borrowed back at the lower rate and return the funds to the broker. Because the currency weakened, they would have made more money from selling it initially than it cost them to buy it back; hence they have made a profit.
Because a large portion of the market was going short on the Pound, therefore, traders will eventually buy it back when it reaches a suitable low, thus ‘closing’ their position and returning the funds to their broker. As a result, it is likely to Pound will see a strong rebound in the near future, even if there is currently no sign of its weakness abating.
The Pound Euro (GBP EUR) exchange rate is trending around 1.1825.
The Pound US Dollar (GBP USD) exchange rate is trending around 1.3146.
The Pound Swiss Franc (GBP CHF) exchange rate is trending around 1.2804.
The Pound Canadian Dollar (GBP CAD) exchange rate is trending around 1.7183.
The Pound Australian Dollar (GBP AUD) exchange rate is trending around 1.7260.
The Pound New Zealand Dollar (GBP NZD) exchange rate is trending around 1.8296.
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