Political risks may not allow the Bank of England to continue the monetary policy normalization cycle

  Central banks may influence the formation of economic cycles, and their monetary policy is a key driver of the exchange rate changes on Forex, however, they are not able to separate themselves from political factors. Yes, the futures market estimates the likelihood of an increase in the repo rate at the August meeting of the Bank of England at 80%, but the increase in the probability of a hard Brexit, Teresa May leaving the post of Prime Minister or early parliamentary elections will force the BoE to back off. And the markets have not forgotten yet the wave of sales the pound got in the spring, after the regulator did not tighten monetary policy in May. Then the derivatives also gave out an 80% chance of the repo rate raise.

It would seem that the pro-European text of the plan for Brexit proposed by Teresa May, the associated resignations of eurosceptic ministers, the positive effect on business activity and the third GDP estimate for the first quarter should help the sterling find the ground underfoot. Alas, in fact it was so unsteady that it resembles a swamp, rather than a hard ground. As many as 10 members of the Cabinet are now dissatisfied with the program of the Prime Minister, and the Prime Minister runs the risk of losing support, being reelected, or even getting an extraordinary parliamentary election. Clouds of political uncertainty are again gathering over the pound, which translates into an increase in volatility and blocks oxygen to the GBP/USD bulls.

Dynamics of pound volatility

Source: Bloomberg. 

What is the stumbling rock? Even before the referendum on Britain's membership in the EU, it was thought to be in the customs union. Will London, after a divorce from Brussels, form its own tariff policy and thus protect the domestic market or continue to live under the EU dictation? Teresa May's plan represents a combined approach. The duties established by the European Union remain, however, the Albion will decide on their collection at the border on their own. Is it any wonder that this option was not appreciated by Donald Trump who started the war with Brussels? Criticism of the US President brought down the quotations of the GBP/USD to the base of the 31st figure, but his favor with regard to the future deal of the States with Britain returned all to square one.

With such an uneven political landscape, even a very busy economic calendar can end up unnoticed. Sterling showed no emotions about the rise in the employment rate to 75.7% and the increase in the number of vacancies to historic highs. will it ignore the release of data on inflation and retail sales? The GBP/USD bulls are supported by the derivatives market and Bloomberg experts, 71% of which expect an increase in the repo rate from 0.5% to 0.75% in August. However, if the statistics disappoint, then the situation with the spring sales of the pound can easily repeat itself.

In my opinion, the ability of Therese May to push her ideas through parliament and the acceleration of inflation to 2.7% y/y and above will help the sterling to strengthen to $1.345-1.35. On the contrary, ongoing political confusion and disappointing statistics will increase the risks of return of the GBP/USD to June lows.    
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Price chart of GBPUSD in real time mode

Pound fell into a swamp

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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