Forward guidance? Sterling could be about to fall
U.K. and U.S. monetary policies looks set to diverge, sending sterling falling against the dollar, according to a new research note from HSBC.
It comes after the Bank of England (BoE) surprised markets by issuing a statement giving guidance on future policy, after its July 4 monetary policy decision. The announcement led to a sharp drop in sterling, which fell to just above 1.50 against the dollar from 1.52 on the news. On Friday, sterling had rebounded to trade at 1.5258.
"Cable [sterling versus the dollar] is going down: how's that for forward guidance?" David Bloom, HSBC's global head of FX research, said in a note on Friday.
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Bloom argued the BoE would likely continue to issue forward guidance under its new governor Mark Carney, and could adopt other policy tools to boost stimulus. This would be in contrast to the U.S., where Federal Reserve Ben Bernanke has repeatedly discussed paring back the Fed's massive monetary stimulus program.
"U.K. monetary policy is seeking to distance itself from the less dovish tone emanating from the U.S. Fed," Bloom wrote. "Such a divergence in policy is a rare event in U.K.-U.S. economic history, and has been associated with GBP-USD weakness in the past."
For example, when Fed-BoE policy diverged in 2005, with the Fed hiking base rates while markets awaited a BoE rates cut, the sterling fell by around 10 percent against the dollar.
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Bloom said that if a similar divergence took place now, sterling could fall below 1.40. He highlighted that the BoE's guidance had now diverged significantly from the Fed's. "There is every reason to assume it will be as important for GBP this time around as it was in 2005," he said, adding that interest rate expectations in both the U.S. and U.K. had followed each other closely since January 2012.
The extent of the policy divergence would depend on the economic data out of each country, but Bloom added: "Here too the risks are skewed to the downside for GBP."
HSBC analysed how different data out of the U.K. and U.S. would impact sterling, concluding that the only scenarios that would be GBP-positive were "bad U.S. data; bad U.K. data" and "excellent U.S. data, excellent U.K. data." All other combinations of data would be negative for the pound.
"Our interpretation of different possible outcomes is that most of them point to downside risks for GBP-USD, with only a couple of instances arguing for GBP-USD gains," Bloom said.
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-- By CNBC's Katrina Bishop. Follow her on Twitter @KatrinaBishop