Brexit volatility returns; BOK to pause


Brexit has returned to haunt GBP. Expect more drama and volatility. The BOK will pause on Friday but pave the way for a second cut in October.
Philip Wee, Ma Tieying29 Aug 2019
    Photo credit: AFP Photo


    FX: GBP volatility and downside risks return

    The British pound’s recovery in the past fortnight has been upended by Prime Minister Boris Johnson’s prorogation is the Parliamentary proceedings. The Queen has approved Johnson’s request for the government to hold a Queen’s speech on October 14. This will effectively delay the return of parliament after its summer recess (September 14 to October 2) and undermine legislative efforts to force another delay in Brexit. There is no certainty that a vote of no confidence in the government can prevent a no-deal Brexit from happening on October 31. Now that Johnson has cemented his hardline credentials, will the EU yield to his demands to negotiate a new deal? The EU Summit is scheduled for October 17-18. Things are fluid. What is certain is a fight between Johnson and parliament and more drama between No. 10 and Brussels.


     
    A no-deal Brexit is not the only threat to a weaker British pound below 1.20. A hard Brexit is seen tipping the UK economy into recession and leading to debt rating downgrades and interest rate cuts. The Bank of England reckoned that even if the UK exits the EU with a deal, there was a one-in-three chance for a UK recession. Real GDP growth has, for the first time since 2012, contracted by 0.2% QoQ in 2Q19. Historically, GBP has not been known to dodge a sell-off from recession or UK-specific event risks. 

    BOK to pause on Friday

    The Bank of Korea is expected to keep the 7D repo rate unchanged at 1.50% when meeting tomorrow morning, a temporary pause after cutting 25bps in July. A back-to-back rate reduction seems unlikely, given that it previously happened only during the serious economic downturns – 2008/09 global financial crisis and 2001 tech bubble burst. Meanwhile, the depreciation of the KRW past the 1200 level, against the current backdrop of escalating China-US trade war and a persistently falling RMB, should also make the BOK cautious and dissuade it from cutting rates too fast. Top officials from the finance ministry have stepped up verbal interventions this week, warning that the government will take pre-emptive actions if there is a herd behaviour in the KRW market.

    The BOK’s rate-cut cycle may not be over yet, however. Exports will likely continue to face headwinds in the rest of this year, considering the rising tensions between South Korea and Japan, as well as between China and the US. The negative spillover effects on the domestic economy will likely become more pronounced in the coming months and deflation talk will likely resurface – consumer confidence has plunged to a 32-month low in August, and PPI inflation has turned negative. In addition, the depreciation pressure on the KRW may abate to some extent in 4Q, helped by the Fed’s further rate cut, ECB’s monetary easing and the resultant decline in DM yields. As such, we continue to look for one more 25bps rate cut from the BOK in 4Q (as soon as the October meeting), which will take the repo rate to a record low 1.25%.

     

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com


     

    Ma Tieying

    Economist - Japan, South Korea, & Taiwan
    matieying@dbs.com

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