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Prime Minister Theresa May’s Brexit speech might have hogged the headlines on Friday, but expect pound traders’ focus to swing back to the Bank of England and a credit-rating downgrade of the UK.
Sterling fell as the market’s hopes for a more detailed Brexit vision from May were dashed, and sentiment may be further dampened today as investors react to late Friday’s announcement from Moody’s Investors Service lowering the UK’s sovereign credit rating by one notch to Aa2. Economic data due this week, expected to provide a barometer of consumer spending and economic growth, will also be closely watched to gauge how soon the monetary-policy change may come.
The pound slid against all Group-of-10 peers on Friday as May failed to convince markets that she would lead to a smoother negotiation process between the UK and the European Union. It had the first weekly loss in more than a month against the dollar even as the British premier called for a transitional phase lasting around two years to provide businesses and citizens with clarity.
Hours later Moody’s announced its cut, saying that it is no longer confident that the UK government will be able to secure a replacement free-trade agreement with the EU that substantially mitigates the negative economic impact of Brexit.
The ratings company changed the rating outlook to stable from negative. “Moody’s had the UK on credit-watch negative. With the outlook now stable, the market impact should be limited,” said Manuel Oliveri, a currency strategist at Credit Agricole CIB in London. “Nevertheless, there could be speculation that others including S&P may follow suit. That could dampen sentiment.”
Still, he expects the pound to reverse any losses subsequently as the focus turns to rate expectations as a market driver as Moody’s action “won’t impact the BoE’s stance.” The pound declined 0.5% last week against the dollar to $1.3528 as of 5:23pm in London on Friday, and 0.6% to 88.38 pence per euro. Yields on 10-year gilts climbed five basis points in the same period to 1.36%.
Money markets have now fully priced in a UK rate increase by February, following the BoE’s comments in the minutes of its meeting last week that it would seek to unwind accommodative policy “in the coming months.”
Investors will be eyeing data including the gross domestic product report next week to “provide a degree of clarity” on the health of the economy ahead of the next Monetary Policy Committee decision in November, said Canadian Imperial Bank of Commerce’s Jeremy Stretch in an interview on Friday. Final reading of data due on September 29 will show the UK economy expanded 1.7% in the second quarter from a year earlier, according to the median forecast of economists in a Bloomberg survey.
“Overall, delaying Brexit by another two years or so will eventually make it yesterday’s story for investors,” said Jordan Rochester, currency strategist at Nomura International Plc. “A smooth transition into Brexit was no more than an assumption by the BoE but now will be more of a reality for their forecasting efforts and data watching will once again be more of a focus.”
With an initial Brexit deal out of the way, pound traders will be focusing on whether optimism over that lasts and shifts the Bank of England’s thinking this week.
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