BOE Policy Bets Overshadow U.K. Trade Signals, Shaking Pound

(Bloomberg) --

Recent volatility in the British pound ahead of the Bank of England rate decision Thursday has investors rattled. But they may be looking at the wrong thing, as trade flows may be a more valuable metric. 

The BoE was early among global central banks in weighing the removal of economic support. But it’s since made a U-turn due to the nation’s Covid emergency. Sterling has been weakening against the dollar since its peak at the end of May. 

The most recent action comes as traders push back bets for when the BoE will hike rates, even with inflation being twice the central bank’s target. The British currency has become increasingly volatile in light of the U.K.’s recent stay-at-home orders and mask mandates as the Covid omicron variant spreads more broadly. The cost of hedging against pound volatility has soared to its highest since February, and sentiment on the currency has dropped to its lowest in a year. 

Here’s where trade flows matter as a way of measuring international economic activity. It’s no secret that many of the world’s largest ports are congested. British ports are having their worst year since 1983 in terms of volume, according to the Financial Times. Part of the reason is lower oil production, since crude makes up nearly one-third of port volumes. But post-Brexit rules are also playing a role. To avoid fees and border controls, cargo headed for the EU now bypasses the U.K., flowing through Ireland and then onto the European continent instead. 

On a trade-weighted basis, the British pound has diverged from a five-year pattern despite having less trade cross U.K. borders. The risk for the currency is if sterling breaks below the support level as a result of omicron’s spread or a central bank surprise. But then, perhaps, it would indicate that less trade is in fact, being priced in. 

For investors, this poses a key question about whether the dominant factor is the direction of central bank policy or upended trade flows. And it’s an issue that’s spreading beyond the U.K.

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