• Pound Sterling bounces back as market sentiment seems to be improving again.
  • Deepening UK recession fears could dampen the Pound Sterling’s recovery.
  • Investors await US ADP Employment data for further action.

The Pound Sterling (GBP) extends recovery on Thursday in the European session, as market sentiment improves after a subdued beginning of the year for risk assets. The GBP/USD pair recovers further as discussions about rate cuts from the Federal Reserve (Fed) look firm while the Bank of England (BoE) is still emphasizing the need to keep interest rates higher for a longer period. 

Meanwhile, upbeat S&P Global UK Composite and Services PMI have added strength to the Pound Sterling’s recovery. The Composite and Services PMI at 52.1 and 53.4 outperformed expectations of 51.7 and 52.7 respectively.

The recovery move in the Pound Sterling could fade if fears of United Kingdom entering a mild recession escalate. The outlook of the economy is gloomy amid tough conditions over credit and household demand, which could force BoE policymakers to unwind their restrictive monetary policy stance earlier than anticipated.

Daily Digest Market Movers: Pound Sterling jumps after upbeat Services PMI data

  • Pound Sterling recovers from 1.2600 as the risk-appetite of the market participants improve again, with US equity futures slightly in the green after ending two sessions with losses.
  • Market sentiment seems to be improving after the Federal Reserve’s  FOMC minutes, released on Wednesday, indicated that policymakers were cautious about an “overly restrictive” monetary policy stance.
  • The Fed minutes indicated that interest rate cuts are on the cards, but the timing is uncertain.
  • Fed policymakers were confident about taming inflation without triggering a recession.
  • Meanwhile, improved market sentiment has provided a near-term cushion to the Pound Sterling but domestic uncertainties weigh. 
  • This week, the Manufacturing PMI  reported by S&P Global dropped to 46.2 against the preliminary reading of 46.4, signaling the effects from  high inflation and interest rates in the domestic and overseas markets.
  • Business optimism dropped further due to soft orders amid a deepening cost of living crisis. Business investment also remains poor as borrowing costs are high.
  • The UK economy is exposed to a technical recession after the country’s Gross Domestic Product (GDP) contracted by 0.1% in the third quarter of 2023. The likelihood of another fall in the fourth quarter is significant.  In its latest projections, the Bank of England said that it is not expecting any growth ahead.
  • The BoE is facing a balancing act between saving the economy from shifting into a recession or cooling down still-high inflationary pressures. 
  • Underlying inflation in the UK is more than double the required rate of 2%, forcing policymakers to stick with the restrictive monetary policy stance.
  • Meanwhile, the US Dollar Index (DXY) fell after printing a fresh two-week high at 102.72 as prospects of rate cuts by the Fed persisted after the release of the FOMC minutes.
  • Investors now shift focus towards the ADP Employment Change for December, which will be published at 13:15 GMT. According to the estimates, private US employers hired 115K workers in December, against 103K payrolls in November.

Technical Analysis: Pound Sterling climbs to near 1.2700

The Pound Sterling rebounds significantly after finding buying interest near the round-level support of 1.2600. The GBP/USD pair aims to extend its recovery as the market mood is improving. The Cable bounces back after correcting to near the 20-day Exponential Moving Average (EMA) around 1.2660. 


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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