File image of Bank of England Governor Andrew Bailey. Image © Pound Sterling Live, Still Courtesy of Bloomberg TV.
The Pound to Euro exchange rate (GBP/EUR) is sagging ahead of Thursday's Bank of England decision.
Pound Sterling recovered through the second part of April amidst the broader improvement in global risk sentiment that followed the relief that U.S. President Donald Trump was toning down his rhetoric on tariffs and his attacks on the Federal Reserve.
However, the recovery has since stalled just below 1.18, with momentum flatlining and rallies tending to be sold once more.
GBP/EUR is proving particularly sensitive to stock market volatility, with fading volatility proving a good source of support for the currency.
The trend of declining volatility has since stopped as investors await the next moves from China and the U.S. on potential trade talks, which has meant the GBP/EUR has started to sag once more.
Technical studies show a short-term downtrend building during the course of the previous week. Thus far, the downside has been relatively limited, but the Bank of England's Thursday decision could trigger a more meaningful breakdown.
Above: GBP/EUR at daily intervals.
With the Bank likely to cut interest rates and signal the potential for a follow-up move in June, the Pound could come under pressure.
This is because the Pound has been conditioned to expect interest rate cuts on a quarterly basis, meaning a follow-up cut in June would break this assumption as it accelerates the pace.
Under such a scenario, there are elevated risks that the Pound-Euro conversion will break below the 1.1708 interim support level and move to 1.16.
The Bank will potentially move to a faster pace of interest rate cuts owing to the slowdown in the economy signalled by incoming survey data. The Bank's Monetary Policy Committee has traditionally tended to err on the side of caution by cutting interest rates on evidence of a slowing economy.
A rise in employer National Insurance Contributions and the mandatory hike to the minimum wage, two hallmarks of Chancellor Rachel Reeves' fiscal policy, pushed the UK economy into contraction in April, according to the S&P PMI survey.
The survey of the UK's private sector reported a composite reading of 48.2, putting it below 50, which marks the watershed between contraction and expansion.
This represents a notable slowdown from March's healthy 51.5 and disappointed a market consensus that expected a reading of 50.4. In fact, the fall in output was the largest recorded for nearly two and a half years.
File image of Chancellor Rachel Reeves. Picture by Kirsty O’Connor / Treasury.
To be sure, the same survey showed inflationary pressures facing businesses are also rising, confirming inflation is on an upward trend again, something that would usually mean the Bank of England refrains from cutting interest rates.
However, the Bank's Monetary Policy Committee - the body that decides what to do to interest rates - is one that has great faith in the belief that inflation will suddenly fall to 2.0% again next year, which gives them the freedom to ignore current inflation data and trends and focus on slowing growth data.
Expect new economic projections from the Bank to confirm this likelihood.
This will compound a 'dovish' stance we expect to be conveyed on Thursday, which opens the door to a downside reaction in the Pound towards 1.16.