Near term GBP dynamics to remain a function of global risk outlook

Since the September BoE rate decision, GBP has underperformed, falling nearly 2% on a TWI basis with losses concentrated amongst the commodity $bloc currencies. This comes despite broad improvement in UK macro data releases with the economic data surprise index hitting its highest levels since the start of September. 

UK rates markets have equally shrugged off the improvement in data and currently price the first UK rate for early 2017. Given the rate sensitivity of GBP, the narrowing of UK rate differentials versus its G10 counterparts has been the dominant driver for the pound's underperformance in recent months. 

"The divergence between improving data and narrowing UK rate differentials can be explained by broader market dynamics, which have been a key factor driving the latter. As highlighted recently, GBP's vulnerability to large market dislocations (sharp rises in volatility) has once again been in evidence and, near-term GBP dynamics will remain largely a function of the global risk outlook", says Bank of America. 

It is instructive to note that following Monday's much weaker-than expected service-sector PMI that GBP was not uniformly lower on the European close, but that price action was more a reflection of the prevailing market environment which was risk-on, gains versus the current account surplus currencies and losses versus $blochigh beta.

Despite global factors driving near-term GBP sentiment, the BoE rate decision and voting pattern will matter for the pound this week. Although the market has pushed back its timing for the first UK rate hike into 2017 a downbeat assessment by the Bank of England and the risk of a 9-0 vote could still lead to further GBP pressure. 

The stars (and the prevailing tide) are aligned for a dovish slant given the recent actions/words of other global central banks and will still weigh on GBP despite the significant paring back of rate hike expectations. However, in the aftermath of the service sector PMI reading, there are asymmetric risks building up for the event. 

"Were the tone to remain broadly unchanged from September, then this should provide a fillip to GBP. The recent "sharper relief" comments from Carney may well turn out to be as much of a head-fake as the 2014 Mansion House Speech where Carney also suggested rate hikes were imminent", added Bank of America.