Andrew Bailey sinks the pound as Tesco lifts profit guidance

 The pound has taken another leg lower and dropped below $1.32 vs. the USD on Thursday, as safe haven flows into the US dollar, along with dovish comments from the Bank of England governor Andrew Bailey, rattle sterling. Andrew Bailey was speaking to the Guardian in a wide raging interview that included his thoughts on the risks from the Middel East crisis, the need for more investment in UK infrastructure and his thoughts on interest rates. He said that the bank could become ‘a bit more activist’ in its approach to cutting interest rates if the news on inflation continued to improve.

The pound takes a hit from Bailey

During the interview, Bailey also said that there were risks to the oil price from the conflict in the Middle East, however, he believes that, for the moment, there is a ‘strong commitment’ from all sides to ‘keep the market stable’. Bailey also said that the UK economy had proved to be more resilient than he had expected it to be, which he calls a ‘base to develop’, and he sounds supportive of government attempts to boost growth. However, it is his thoughts on inflation that have had the most impact on the FX market.

GBP also struggles as the market rushes for dollar

The pound was already selling off before Bailey’s comments, and GBP/USD is down more than 1% so far this week, it is down from $1.34 at the start of this week to below $1.31 this morning. It has found decent support at $1.3170, however, this has been a bruising week for the pound, and $1.35 seems like a mountain to climb from here. Part of the pound’s sell off is due to external factors. As geopolitical risks in the Middle East have risen, the US dollar has caught a bid. The currencies that were most extended vs. the USD have sold off rapidly, as investors have sought the safety of the USD. Hence, the pound and the yen were in the sellers’ sights, as the markets scrambled to buy dollars. The pound is still the best performing currency in the G10 FX space so far this year, thus, if tensions escalate further, then we could see another leg lower for GBP/USD.

The pound loses its yield differential

However, Andrew Bailey’s comments have also undermined the pound’s yield differential with the US and Europe. The market has fully priced in a rate cut from the BOE next month, and there is a 61% chance of another cut in December, up from 47%. Also, the market is pricing in more than 25bps in cuts for next month’s meeting. The market is now expecting 6 rates from the BOE for the rest of this year, up from just over 5 rate cuts earlier this week. The market has used Bailey’s comments as a green light to price in more monetary loosening. GBP/USD has already sold off sharply this week, so further downside could be limited in the short term, however, Bailey has made it harder for the pound to recover. For that to happen, we may need to see both upside surprises to UK price data and an easing of tensions in the Middle East.

Tesco boosts its profit guidance

Elsewhere, Tesco’s share price could open higher later today. The UK’s largest grocer lifted its profit guidance for the rest of its fiscal year. It now expects £2.9bn of operating profit, up from £2.8bn. Like-for-like sales also rose by 3% in the first half of this year, in another sign that the UK consumer is in good health. JD Sports, Next and now Tesco have all delivered strong trading updates in recent weeks, which is a sign that the UK consumer is willing to spend more now that the cost-of-living crisis has eased.

However, retailers are still in a tricky environment. They are having to boost their discounts to attract shoppers. Tesco said that it increased discounts, however, the fact that it can boost its profit guidance at the same time as discounting the price of some of its items, suggests that it may have boosted its market share in the first half of this year.

The interim report from Tesco was strong across most business lines. The Tesco Bank, although a small part of the overall operation, is expected to generate £120mn in operating profit, beating estimates of £83mn. The UK was a strong point for Tesco’s sales growth, although there was weakness in Bookers sales in the first half of the year, and sales growth in Eastern Europe was not as strong as analysts had hoped. However, the UK and ROI are the most important markets for Tesco, and here growth in sales is strong.

Tesco’s share price is higher by 21% so far this year, but it has fallen sharply this week, as volatility has gripped financial markets. This report, and the boost to profit guidance, could give it a platform for recovery.

Markets today

Elsewhere, the Hang Seng has come to a halt, and the index is down nearly 1% after a blistering rally of more than 26% in the past month. The China stimulus rally has lost steam as China remains on its national holiday. FTSE 100 futures are pointing to a strong open, and we could see Tesco lead the charge at the UK open. US futures are pointing to a weaker open. We will be watching to see if the dip in the Hang Seng knocks overall risk sentiment, and the market is also expected to be reactionary to any developments in the Middle East. Brent crude is higher by more than 1% yet again on Thursday morning. We have seen oil price rallies fizzle as the days have progressed this week, and Brent crude remains below $75.00 per barrel. Any escalation in tensions between Israel and Iran could see Brent rise above this level. However, the fact that the oil price has not been able to sustain gains above this level, suggests that the Brent’s recent rally could fade if headline risk from the region recedes.