Lee Hardman, Currency Analyst at MUFG, suggests that the main event for the pound this week will be the latest update from the BoE tomorrow on their outlook for monetary policy.

Key Quotes

“After adjusting sharply lower early this year, the pound has at least temporarily stabilized at lower levels over the last month or so. The BoE’s policy update tomorrow poses some modest downside risk for the pound but is unlikely to trigger a further sharp sell-off.

The BoE are likely to acknowledge that the UK economy is slowing more than expected ahead of the upcoming EU referendum. Markit noted recently that their PMI surveys for April were consistent with flat growth in Q2 adding to building evidence that heightened uncertainty ahead of the referendum is beginning to have more of a negative impact on growth. It has triggered some speculation that it could prompt more dovish MPC members Haldane and/or Vlieghe to vote for a rate cut as soon as at tomorrow’s policy meeting.

However, it remains more likely that the BoE will refrain from deciding to vote for any significant change in policy until there is greater clarity over the outlook for growth and inflation which will not occur until after the referendum. The BoE has already clearly stated that incoming economic data were likely to prove harder to interpret than normal over the EU referendum period and that it was likely to act more cautiously to data news than normal. There has also been further evidence that domestic inflation pressures have picked up recently which argues against the BoE signalling that it is moving closer to lowering interest rates.
In these circumstances, the pound is likely to continue to be primarily driven by the perception of Brexit risk ahead of the referendum. The policy announcements tomorrow from the BoE are likely to have only a limited impact on the pound.

The National Institute for Economic and Social Research became the latest body to warn of the potential negative impact for the UK economy from Brexit. In the event of Brexit, they believe that the level of GDP would be would be lower by 1 percentage point. In the longer-term, they believe that leaving the EU could reduce GDP by anything between 1.5% and 3.7% by 2030 depending on the subsequent trading relationship between the UK and EU, as well as the rest of the world. In the event of Brexit, they believe that the pound could fall by 20%.

However, if the UK votes to remain in the EU they are optimistic that the economy can regain a firmer footing projecting an accelerated expansion of 2.7% in 2017 following a modest downward revision to growth this year of 2.0%. The sustainability of the likely initial rebound for the pound should the UK vote to remain in the EU will depend upon whether the UK economy is able subsequently to regain a firmer footing. At the current juncture it difficult to accurately assess how much of the current slowdown is Brexit related.”