Thursday, 2 February 2017

Why is the Pound falling?

Sterling has fallen today after the Bank of England released its inflation report, interest rate decision, and press conference. While they raised the growth forecast for the UK as expected, they saw the economy slowing in 2018, and the reason for this is something that I mentioned in posts earlier this week; inflation. The result has been investors selling the Pound, causing it to weaken and fall against other currencies. Here's how GBP/EUR has moved today:



Inflation key to the falling value of Sterling


With inflation levels set to rise above the BoE's 2% target, they have stated that they will tolerate this, meaning interest rates are unlikely to be raised to try and combat rising prices. Low interest rates = weak currency. At the same time, wage growth is not expected to match inflation, meaning that real incomes are likely to drop. As this happens consumers are likely to spend less, weakening the economy and causing it to slow. Slowing economy = weaker Pound.

This is exactly what I expected would happen and warned of this on Monday and Tuesday. Yet again GBP/EUR rose to around €1.17/€1.18 before dropping back away. With Brexit negotiations set to begin next month, I think there is reason to believe the Pound will fall further in the short term. I also think that the BoE are overly optimistic in their revised growth forecasts. Just as their gloomy forecast for the economy in a post brexit world was wrong, I think they have gone too far the other way on this occasion. If indeed the economy does start to slow over the coming months, the Pound will fall further.

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