Bank of England To Cut Interest Rates to Lowest Ever - Will the British Pound Sell Off?

Written by Ilya Spivak, Currency Analyst

The British Pound kept to a narrow, well-defined range in overnight trading as traders brace for the coming interest rate announcement from the Bank of England. Expectations call for a 50 basis point cut to bring rates to 1.50%, the lowest since the central bank’s creation.

Key Overnight Developments

• Australian Trade Surplus Shrink As Exports Falter
• Euro Rises, British Pound Trades Sideways Against US Dollar


Critical Levels

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The Euro rose against the US Dollar in overnight trading, testing above the 1.3650 level. The British Pound remained range-bound, confined to a narrow 60-pip band below 1.5090.


Asia Session Highlights

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Australia’s Trade Balance surplus narrowed more than economists expected in November, printing at A$1.45 billion. The result was driven by a sharp 3.6% drop in exports, the first negative reading in nine months. Looking Australia’s top trading partners, shipments to the UK were hardest hit, declining by a whopping -46.5%. Exports to China and the US also saw double-digit drops, falling -18.7% and 10.7%. Rounding out the top six markets that absorb well over half of all Australian exports, shipments to New Zealand fell -7.8% while those to India declined -3.9%, with only Japan seeing positive growth of a meager 2.8%. Waning global demand has seen business confidence fall to record lows and put upward pressure on unemployment. This will surely weigh on disposable incomes and prompt precautionary saving in the months ahead, threatening the larger antipode with the possibility of recession. The Reserve Bank of Australia has aggressively cut interest rates by a full 3% since September and is likely to continue to do so in an attempt to check the slide in economic growth. Traders are pricing in a 0.75% cut when Glenn Stevens and company announce policy on February 2nd.


Euro Session: What to Expect

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The interest rate announcement from the Bank of England headlines the economic calendar in European hours. A survey of economists conducted by Bloomberg calls for a 50 basis point cut to bring borrowing costs to 1.50%, a new all-time low. Minutes from December’s BOE meeting (released over 2 weeks ago) showed the MPC had wanted to cut more than 100bps at that time but held back to avoid an “excessive” drop in the British pound. This suggests the markets have had ample time to price in a dovish bias. Indeed, trading in overnight index swaps sees traders pricing in a 0.50% cut ahead of the decision. On balance, this means that a move in line with expectations is unlikely in and of itself to stir much volatility. As noted by DailyFX Strategist Terri Belkas, the language of the announcement will be far more important in shaping market sentiment towards the sterling.

In Switzerland, the Unemployment Rate is set to rise to 2.9% in December, the highest in over a year. Firms are cutting back capacity as the global slowdown dwarfs overseas demand. Indeed, industrial Production fell to the lowest level in over 2 years in the third quarter. Exports make up a whopping 59% of overall economic growth, with machinery, chemicals and metals topping the list of items being sold abroad. Rising unemployment will crimp disposable income and weigh on consumer spending. An average of economists’ projects suggests GDP growth will grind to a standstill in 2009. Slowing activity will weigh on price growth, with the Consumer Price Index set to show inflation at 0.9% in the year to December, the lowest in 15 months. Interest rates are already at just 0.50%, with the Swiss National Bank likely to follow the US Fed down the path of quantitative easing as deflation becomes a growing concern.

Germany’s Trade Balance is likely to shrink on slowing exports. Yesterday, unemployment grew more than expected as companies cut capacity in the face of withering global demand. Indeed, Factory Orders and Industrial Production have both fallen to record lows. This will invariably weigh on consumer spending and deepen the slump in economic activity. A survey of economists conducted by Bloomberg forecasts the economy will shrink -1.45% in 2009.