The strong link between EURUSD and GBPUSD saw GBPUSD dragged higher overnight on reports in the Guardian which claimed that France and Germany had agreed to increase the size of the EFSF to EUR 2trn from EUR 440bn. However, the reports do not change our opinion that this weekend’s EU Summit will fail to provide the “shock and awe” strategy that the market is looking for. Without this, we find it hard to be constructive on risk and we therefore expect both the EUR and GBP to pull back against the USD. Today’s MPC minutes are likely to reinforce GBPUSD’s downward trend, in our opinion. We therefore recommend that investors short GBPUSD ahead of the minutes, targeting 1.50, with a stop at 1.60.
As the MPC minutes are from the October meeting which re-launched the asset purchase programme, market attention is likely to focus on the vote and the QE discussion. We believe the minutes will show the MPC unanimously voted for QE, especially given the subsequent comments endorsing its effectiveness from the erstwhile hawks, Dale and Weale. And although there is no consensus forecast for this decision, it seems likely that some investors are expecting there to be at least one dissenter. This suggests that if the vote does prove to be 9-0, GBP is likely to underperform.
Within the discussion, what will be of interest is whether they leave the door open for an extension of the QE programme. In our opinion, quantitative easing is a blunt tool for stimulating the economy. It works by pushing down yields (a currency negative) and triggers a reallocation of private sector holdings towards riskier assets. As financial wealth rises, consumption becomes underpinned, growth prospects improve and the market begins to price in interest rate hikes (a currency positive). However, the trickle through can be slow. Indeed as our economists note in “UK MPC watching: Will QE work?” QE is unlikely to materially improve the outlook for the UK economy over the next six months and they believe an extension of the programme cannot be rule out.
It also seems likely that the discussion will echo Mervyn King’s comments from last night that UK inflation is at, or close to the peak and that the medium-term outlook for inflation is weak. If this is the consensus view on the committee it again supports the view that further QE is a distinct possibility.
Conversely, the economic backdrop in the US has improved somewhat, and our economists have slightly revised up their forecast for Q3 real GDP growth from 2% to 2.5% (annualised). This reinforces our bearish view of GBPUSD, as not only is QE3 from the Fed unlikely in the near term while the MPC pushes ahead with QE2, an extension of the programme cannot be rule out.
In our opinion, the only scenario in which GBPUSD would undergo a sustained rally is if there is surprisingly quick and resolute progress over the euro area issues. We think this is unlikely as we see little from the headlines overnight to indicate that this weekend will result in a “shock and awe” strategy. Moreover, even when a decision is reached, implementation is unlikely to be immediate – it took almost three months to approve the EFSF decisions agreed in July.
Consequently, while we recognise the considerable event risk surrounding the euro area debt crisis, we remain bearish on GBPUSD over the next three months.
BARCLAYS CAPITAL
FOREIGN EXCHANGE RESEARCH | INSTANT INSIGHTS