Forex Today: USD remains weak after election as BoE rate decision takes centre stage

Thursday, 5 November: Key developments for markets.

Post-election selling of the US Dollar (USD) continues on Thursday. The USD Index is extending its decline towards 101.00 in early European trading following the midterm election result. Attention later turns to the Bank of England (BoE), which will announce its monetary policy decisions. At a press conference beginning at 12:30 GMT, Bank of England (BoE) Governor Andrew Bailey will discuss the policy outlook and take questions.

The USD lost ground against its major peers midweek after Democrats secured majorities in both the Senate and the House. Renewed hopes of an easing in the Middle East conflict drove a sharp fall in Crude Oil prices. Wall Street's main indexes rallied after the opening bell as risk appetite improved. On the data front, Automatic Data Processing (ADP) reported an October increase of 86K in private-sector employment, above the market forecast of 69K. The Institute for Supply Management's (ISM) Services Purchasing Managers' Index (PMI) came in at 54.5, signalling a healthy pace of expansion in service-sector activity.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

US Dollar Performance This Week

This week's percentage moves in the US Dollar (USD) against the major currencies listed are set out below. The Swiss Franc recorded the largest gain against the US Dollar.

	USD	EUR	GBP	JPY	CAD	AUD	NZD	CHF
USD		-0.78%	-0.66%	0.40%	-0.12%	0.24%	-0.18%	-1.01%
EUR	0.78%		0.09%	1.12%	0.63%	0.94%	0.60%	-0.26%
GBP	0.66%	-0.09%		0.87%	0.54%	0.85%	0.49%	-0.35%
JPY	-0.40%	-1.12%	-0.87%		-0.49%	-0.16%	-0.64%	-1.49%
CAD	0.12%	-0.63%	-0.54%	0.49%		0.35%	-0.14%	-0.88%
AUD	-0.24%	-0.94%	-0.85%	0.16%	-0.35%		-0.36%	-1.18%
NZD	0.18%	-0.60%	-0.49%	0.64%	0.14%	0.36%		-0.90%
CHF	1.01%	0.26%	0.35%	1.49%	0.88%	1.18%	0.90%

Percentage moves between major currencies are displayed in the heat map. Select the base currency in the left-hand column and the quote currency in the top row. Selecting the US Dollar on the left and following that row across to the Japanese Yen, for instance, gives the percentage change for USD (base)/JPY (quote).

Recent political and market developments offer the clearest explanation for the latest Dollar weakness across G10 currencies, according to Scotiabank analysts. They characterise it as “something of a ‘relief rally’”. The analysts also describe “a shift in the USD toward the middle of its ‘smile’, in which relative growth and interest rate differentials narrow as the US/USD drift from the edge linked to exceptionalism – with the other edge of the smile tied to sentiment-driven risk aversion.” Moving away from the extremes of the so-called Dollar smile, they suggest, helps account for the outperformance of higher-beta currencies as immediate tail risks ease.

GBP/USD rose nearly 0.4% on Wednesday, reaching slightly above 1.3500, its highest level since mid-September. By Thursday's European morning, it is consolidating around 1.3480. Investors anticipate a 25 basis points (bps) increase in the BoE policy rate to 4%.

Less forceful BoE communication could undermine Sterling's recent resilience, warns Societe Generale’s Kit Juckes. In his assessment, “if the Bank of England’s guidance on Thursday shows any hesitation about how much further they need to go, the Pound could start looking vulnerable,” although he also believes “it is probably too early for them to give the appearance of slowing down.”

Gold (XAU/USD) advanced more than 3% on Wednesday as it welcomed the US midterm election outcome. That upward momentum continues on Thursday: XAU/USD is trading above $4,100, up about 1.5% in the European morning.

EUR/USD is trading higher around 1.1250 on Thursday, supported by widespread USD selling. September Producer Price Index figures are due later on the European economic calendar. European Central Bank President Christine Lagarde is also scheduled to join a discussion at the "New Dialogues for the Future" event in Milan, Italy.

USD/JPY is edging down towards 158.00 in European trading, extending Wednesday's marginal decline. Investors will closely monitor Japan's September Labor Cash Earnings figures, due in the early hours of Friday's Asian session.

BoE: Key Questions Answered

Bank of England: Its Mandate and Impact on the Pound

Maintaining ‘price stability’, defined as a steady inflation rate of 2%, is the main objective of the Bank of England (BoE), which determines monetary policy for the United Kingdom. It pursues this objective by adjusting base lending rates. By setting the rate for its lending to commercial banks and for lending between banks, the BoE determines interest-rate levels across the economy. The value of the Pound Sterling (GBP) is also affected.

BoE Monetary Policy: The Effect on Sterling

Inflation above the Bank of England's target prompts interest-rate increases, raising borrowing costs for households and businesses. Higher rates support the Pound Sterling by making the UK a more attractive destination for global investors' funds. Below-target inflation, by contrast, signals slower economic growth. The BoE will then consider rate cuts to reduce borrowing costs, hoping to encourage businesses to finance projects that generate growth. Such a move is negative for the Pound Sterling.

Quantitative Easing (QE): How It Works and Affects the Pound

When interest-rate cuts cannot deliver the required result, the Bank of England can turn to Quantitative Easing (QE) as a last resort in extreme circumstances. This policy substantially expands the flow of credit through a stalled financial system. To implement QE, the BoE prints money to purchase assets from banks and other financial institutions, typically government bonds or AAA-rated corporate bonds. The Pound Sterling usually weakens as a result.

Quantitative Tightening (QT): Its Effect on the Pound Sterling

As the economy strengthens and inflation begins to climb, Quantitative tightening (QT) reverses QE. Under QE, the Bank of England (BoE) buys government and corporate bonds from financial institutions to encourage lending. Under QT, it halts further bond purchases and no longer reinvests principal received as its existing bond holdings mature. This is generally supportive of the Pound Sterling.