LONDON (Reuters) - The pound fell sharply on Thursday after the Bank of England said it had briefed monetary policymakers on how a negative interest rate could be brought in, before recovering most of the lost ground in later trading.
The Bank of England kept its main stimulus programmes on hold, as expected, and said that Britain’s economy had performed better than expected.
Highlighting risks relating to rising COVID-19 cases, the unwinding of jobs protection schemes, and Brexit, the BoE said it was ready to take further action.
The bank also said that policymakers had been briefed on how a negative rate could be implemented “should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates.”
“It is clear that they are examining and lining up the tools they can deploy including more quantitative easing and negative rates if the economy diverges from their central scenario,” said Kenneth Broux, a strategist at Societe Generale.
The BoE said that their base case is an “immediate, orderly move to a comprehensive free trade agreement with the European Union on 1 January 2021”.
“Now if that does not happen they will have no option but to respond,” said Broux. “Sterling is a sell on rallies until there is a deal with the EU.”
Sterling fell as much as 0.7% against the dollar in the ten minutes after the meeting minutes were released, then extended losses to as low as $1.2866.
Money markets ramped up their expectations of British interest rates entering negative territory.
Futures contracts maturing in February 2021 were pricing in policy rates falling below zero for the first time compared to March 2021 earlier.
Graphic: Sterling, gilts down -
By 1457 GMT, the pound was at $1.2947, down just 0.1% on the day, while euro-sterling was up 0.1% at 0.9118.
Brexit talks were thrown into disarray by Prime Minister Boris Johnson proposing legislation that would break international law by breaching parts of the Withdrawal Agreement relating to Northern Ireland.
The bill is moving through parliament this week.
U.S. Democratic presidential candidate Joe Biden warned the UK that it must honour its commitments to Northern Ireland, or there would be no post-Brexit trade deal between the UK and United States.
Graphic: Money markets price negative rates from BoE as early as Q1 2021 -
Reporting by Elizabeth Howcroft and Saikat Chatterjee, additional reporting by Ritvik Carvalho, Editing by William Maclean, Chizu Nomiyama and Toby Chopra and Kirsten Donovan
Our Standards: The Thomson Reuters Trust Principles.