Pound Sterling slumps on dismal market sentiment, BoE Dhingra's dovish stance

Pound Sterling recaptures weekly highs as the appeal for risk-perceived assets improves.
BoE Dhingra’s comments on the interest rate outlook were dovish due to the poor UK economic outlook.
The preliminary S&P Global/CIPS PMI data remains mixed.

The Pound Sterling (GBP) comes under pressure in Thursday’s early New York session due to Middle East tensions and mixed preliminary PMIs reported by the S&P Global/CIPS for February. The Manufacturing PMI at 47.1 was slightly above the prior reading of 47.0 but failed to match expectations of 47.5. The Services PMI was surprisingly unchanged at 54.3, while investors anticipated a decline to 54.1. The Composite PMI was higher at 53.3 against expectations and the former reading of 52.9.

The GBP/USD pair falls on backfoot as Bank of England (BoE) policymaker Swati Dhingra cautioned about downside risks to the United Kingdom economy due to high interest rates. In her speech at the Market News International Connect event on Wednesday, Dhingra said the demand prospects are “weak and less resilient” than their previous forecasts. She added that higher mortgage costs and rental prices in 2023 shortened households’ pockets, which resulted in weak Retail Sales.

The Pound Sterling faces foreign outflows when a BoE policymaker warns about holding interest rates higher for a longer duration because it increases the possibility of interest rate cuts.

Meanwhile, investors await February’s preliminary S&P Global PMI data for the United States, which will provide more insights into the economic outlook.

Daily digest market movers: Pound Sterling drops sharply while USD Index rebounds

The Pound Sterling faces an intense sell-off as investors' risk appetite shrinks.
The appeal for risk-sensitive assets fades due to deepening Middle East tensions.
The Israeli army has intensified bombarding on Rafah, southern region of Gaza in Palestine as the former hopes that over 1.4 million refugees have been sheltered there. Escalating Middle East tensions have improved the appeal for safe-haven assets.
The US Dollar Index, which gauges the value of the US Dollar against six major currencies, delivers a V-shape recovery to 104.00.
The recovery move in the US Dollar is also driven by hawkish Federal Open Market Committee (FOMC) minutes for the January monetary policy meeting, which were released on Wednesday.
On the domestic front, the Pound Sterling advances despite the fact that Bank of England policymaker Swati Dhingra warned about the increasing cost of living standards in the United Kingdom due to the maintenance of interest rates at 5.25% for a longer period.
Swati Dhingra, who voted for a rate cut in February’s monetary policy meeting, warned about a hard landing if the BoE delays rate cuts.
While most BoE policymakers closely track service inflation and wage growth for cues about the inflation outlook, Swat Dhingra said service prices are not a good measure of domestically generated inflation.
Meanwhile, market expectations for BoE rate cuts are slightly up after BoE Governor Andrew Bailey said the central bank can reduce interest rates before inflation reaches the 2% target.

Technical Analysis: Pound Sterling falls vertically from 1.2700

The Pound Sterling fails to continue its winning spell to a third trading session on Thursday. The GBP/USD pair falls significantly after kissing the round-level resistance of 1.2700. The overall trend remains sideways as the pair oscillates in the Descending Triangle pattern formed on the daily time frame.

The aforementioned chart pattern indicates a sharp volatility contraction. The chart formation carries a slightly negative bias due to the establishment of lower highs. The downward-sloping border of the Descending Triangle pattern is plotted from December 28 high at 1.2827, while the horizontal support is placed from December 13 low near 1.2500.

The pair has climbed above the 20-day and 50-day Exponential Moving Averages (EMAs), which are closely trading near 1.2630. Meanwhile, the 14-period Relative Strength Index (RSI) trades in the 40.00-60.00 region, indicating indecisiveness among market participants.

Risk sentiment FAQs

What do the terms"risk-on" and "risk-off" mean when referring to sentiment in financial markets?

In the world of financial jargon the two widely used terms “risk-on” and “risk off'' refer to the level of risk that investors are willing to stomach during the period referenced. In a “risk-on” market, investors are optimistic about the future and more willing to buy risky assets. In a “risk-off” market investors start to ‘play it safe’ because they are worried about the future, and therefore buy less risky assets that are more certain of bringing a return, even if it is relatively modest.

What are the key assets to track to understand risk sentiment dynamics?

Typically, during periods of “risk-on”, stock markets will rise, most commodities – except Gold – will also gain in value, since they benefit from a positive growth outlook. The currencies of nations that are heavy commodity exporters strengthen because of increased demand, and Cryptocurrencies rise. In a “risk-off” market, Bonds go up – especially major government Bonds – Gold shines, and safe-haven currencies such as the Japanese Yen, Swiss Franc and US Dollar all benefit.

Which currencies strengthen when sentiment is "risk-on"?

The Australian Dollar (AUD), the Canadian Dollar (CAD), the New Zealand Dollar (NZD) and minor FX like the Ruble (RUB) and the South African Rand (ZAR), all tend to rise in markets that are “risk-on”. This is because the economies of these currencies are heavily reliant on commodity exports for growth, and commodities tend to rise in price during risk-on periods. This is because investors foresee greater demand for raw materials in the future due to heightened economic activity.

Which currencies strengthen when sentiment is "risk-off"?

The major currencies that tend to rise during periods of “risk-off” are the US Dollar (USD), the Japanese Yen (JPY) and the Swiss Franc (CHF). The US Dollar, because it is the world’s reserve currency, and because in times of crisis investors buy US government debt, which is seen as safe because the largest economy in the world is unlikely to default. The Yen, from increased demand for Japanese government bonds, because a high proportion are held by domestic investors who are unlikely to dump them – even in a crisis. The Swiss Franc, because strict Swiss banking laws offer investors enhanced capital protection.

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