Sterling advanced on Thursday in a volatile trading session after the Bank of England said Britain faced its weakest economic growth in a decade due to uncertainty about Brexit. Having fallen more than half a percent immediately after Bank cut its growth forecast and left interest rates unchanged, the pound subsequently recouped its losses and strengthened on hopes that Britain will make some progress in coming days in negotiations on its departure from the European Union.
The speed at which the British currency retraced its losses suggested investors are focused more on Brexit talks than on the economic outlook. At a time when other major central banks have said they will hold off from raising borrowing costs, the BoE stuck to its message that interest rates will rise if an EU divorce deal is done.
But what underpinned the British currency, according to some market analysts, was the promise of more stimulus measures in case Britain fails to pull together a deal by March 29. "The BoE was pretty balanced and pointed to robustness in the labour market ... the message was that, when Brexit is resolved, the economy will be lifted and that caught some people off guard ..." said Nomura strategist Jordan Rochester.
The pound rose a third of a percent to $1.2969, after dropping as low on the day as $1.2854, a two-week low. It carved out a wide daily trading range of more than 1 percent. Against the euro, it strengthened 0.4 percent to 87.57 pence.
"Sterling markets are broadly pricing in the short-term Brexit uncertainty," said Viraj Patel, a currency strategist at Arkera, a financial technology firm. "All eyes are on Westminster and Brussels." Money markets were pricing in about a 41 percent probability of another quarter point rate hike before the end of the year compared to a 50 percent probability before the rate decision. "Assuming an amicable outcome to the Brexit negotiations, there are enough hawkish signals in the inflation report to conclude that the BoE could hike rates later this year, which should support the currency," Dean Turner, UK economist at UBS Wealth Management said.
The pound was especially volatile after the rate decision, briefly falling below a 100-day moving average of $1.2896 before bouncing off an intraday low of $1.2854.
Two-week to one-month risk reversals on the pound, a ratio of calls to puts, showed an increased bias towards selling as the scheduled March 29 exit from the EU nears.
Prime Minister Theresa May will call on the European Union on Thursday to work with her to change the Brexit divorce deal in a bid to win the support of a divided parliament to smooth Britain's departure.
On Wednesday, European Council President Donald Tusk said the EU would make no new offer on Brexit, and those who had promoted Britain's exit without any plan of how to deliver it deserved a "special place in hell".
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