The Pound Sterling (GBP) underperformance yesterday was contained mostly to against the core G10 currencies with the risk-off sentiment resulting in the high-beta G10 currencies like NOK and AUD performing worse. But EUR/GBP did have its largest one-day gain since 16th September as investors started to position for the potential for the BoE to ease sooner than expected. The 2-year Gilt yield dropped 5bps yesterday with the prospects of a rate cut before the end of the year increasing from a 20% probability to a 40% probability over the last three trading days, MUFG's FX analyst Derek Halpenny reports.

Market positioning for a BoE rate cut increases

"Certainly, we would argue the lack of pricing for a cut by year-end (in December basically) is one reason for this move. Pricing appears too low when you consider there is quite a period between the November and December MPC meetings. Between these two meetings two jobs reports and two CPI reports will be released so given that fact alone there is plenty of scope for market expectations to shift based on those data releases. Between those two meetings we will also have the UK Budget on 26th November which in all likelihood will confirm a net fiscal drag for the economy going forward as the government attempts to fill an estimated GBP 30bn fiscal hole."

"While we believe there was some cherry-picking of the jobs data yesterday, we concur with the overall direction of the rates move given we see scope for the BoE to be in a position to cut in December. We also had comments from MPC member Alan Taylor yesterday – a known dove, who voted with Swati Dhingra to cut rates in September, his comments nonetheless came across as more confident in believing that the economy needs further monetary easing."

"Taylor’s speech was on trade diversion and one conclusion was that trade diversion on a 'material scale' would likely have 'substantial bearing on prices' in the UK. China exports to the UK in September data released this week revealed a 12.2% YoY increase. Exports to the US fell 27%. Taylor and Swati remain the lone doves on the MPC for now but assuming inflation slows in October/November data and wages do not rebound, the justification for a rate cut will likely grow. We maintain our view of a gradual increase in EUR/GBP into year-end as market positioning for a BoE rate cut increases. Long EUR/GBP remains a trade view published in our FX Weekly publication."