Pound Sterling rallies after Bank of England rate decision

• Pound Sterling (GBP) drifts lower against the US dollar (USD), euro (EUR) and Australian dollar (AUD)
• Bank of England (BoE) interest rate decision weighing on British pound (GBP)
• US dollar (USD) forecast to head lower in coming weeks
• Australian dollar (AUD) storms higher as iron ore prices stabilise

Pound Sterling (GBP) drifted lower against a host of major currencies on Thursday, including the euro (EUR), US dollar (USD) and Australian dollar (AUD) ahead of the Bank of England (BoE) monetary policy meeting.

The British pound to euro (GBP/EUR) exchange rate slipped away from its nine-month peak to EUR 1.1312 earlier during the session, while the British pound to US dollar (GBP/USD) exchange rate plunged to USD 1.3566.

However, pound Sterling (GBP) is rallying following the BoE policy meeting, as policymakers refrained from introducing negative interest rates amid cautious optimism over the recovery outlook.

The British pound to US dollar (GBP/USD) exchange rate has rebounded from January lows and is trading 0.2% higher at USD 1.3686.

Although expectations for the US economy to recover faster than Eurozone has renewed demand for the greenback over the past week, as the UK is leading the COVID vaccination race, Cable should extend its uptrend.

The UK’s rapid vaccine rollout is also buoying momentum in the British pound to euro (GBP/EUR) exchange rate, which surged to a fresh multi-month high of EUR 1.1414 following the BoE’s decision to leave monetary policy settings unchanged.

The EU is the laggard in the race to immunisation against the Coronavirus. Furthermore, with lockdowns being extended across the bloc and recent economic data releases being largely disappointing, economists expect the EU economy to weaken further in Q2 of 2021.

While the UK economy is likely to contract in Q1 due to England’s third national lockdown, pound Sterling’s (GBP) Thursday morning slump appeared to reflect nervousness ahead of the BoE rate decision rather than fears over the economic recovery outlook.

Many economists and foreign exchange (FX) market participants had expected the central bank to leave interest rates unchanged at 0.1% amid optimism over the UK’s rapid vaccine rollout and recently published better-than-expected economic data.

However, the possibility of an unexpected surprise triggered some adverse price action around the UK currency.

Nonetheless, policymakers dismissed negative interest rates and decided to keep the central bank’s quantitative easing programme unchanged at GBP 895BN, citing encouraging prospects for the UK economy.

Bank of England keeps interest rates unchanged

BoE policymakers unanimously agreed to leave its main policy settings unchanged amid signs that the UK’s third national lockdown has had a less severe impact on the economy than preceding lockdowns.

Although the central bank warned that the economic outlook remains uncertain, policymakers said that recently released better-than-expected UK data and the country’s rapid vaccine rollout is reason to be optimistic.

While the Monetary Policy Committee (MPC) did not rule out the possibility of introducing negative rates in the future, the central bank concluded that it “would take at least six months’ worth of preparations.”

However, as policymakers were careful not to suggest that they intended to cut rates in the future, pound Sterling (GBP) rallied following the statement, paring losses against most of its major trading rivals.

The BoE also upwardly revised its forecast for UK gross domestic product (GDP), stating it was surprised by the economy’s strength in Q4 last year.

Although the Bank of England expects the UK economy to contract by 4% in Q1 of 2021 due to the impact of the third national lockdown, it forecasts a rapid recovery to pre-pandemic levels over the year as COVID-related restrictions are lifted.

The developments have already put a floor under pound Sterling (GBP) and will likely underpin the UK currency’s 2021 rally. Even the riskier Australian dollar (AUD) has tumbled against the British pound (GBP) despite the improved mood in FX markets and a strong recovery in global iron ore prices.

Iron ore price stabilisation boosts Australian dollar

Given that Australia is the world’s largest iron ore exporter, the Australian dollar (AUD) tends to outperform in currency markets amid positive iron ore price dynamics.

After diving late last month, iron ore prices are rallying on Thursday, albeit the wave of euphoria appears to be fading as investors focus on downside risks.

While fundamentals are broadly positive, China’s demand for Australian iron ore is set to decline. According to a Bloomberg report, China’s Ministry of Industry and Information Technology confirmed that they are looking for ways to reduce China’s steel output to achieve net-zero carbon emissions by 2060.

Kim Mundy at Commonwealth Bank of Australia said: “Over 80% of Australia’s iron ore exports are delivered to China”  so a reduced demand will be damaging for the Australian economy, and in turn, the Australian dollar (AUD).

The Australian dollar (AUD) has already drifted lower against pound Sterling (GBP), undermined by the Bank of England’s (BoE) optimistic prospects for UK economic growth and nervousness over iron ore price dynamics.

The British pound to Australian dollar (GBP/AUD) exchange rate has stormed higher during London trading hours, rebounding from a low of AUD 1.779 to AUD 1.7934.

Pound Sterling (GBP) has fallen back in favour with investors following the Brexit agreement, and if the UK currency maintains its bullish trend, GBP/AUD could breach the AUD 1.80 level.

The outlook for the Australian dollar (AUD) will likely depend on the direction iron ore prices are heading and with near-term headwinds growing, the “Aussie” dollar’s broader uptrend which has been in place since late 2020 could reverse.