Pound exchange rates were subjected to very high volatility on Wednesday as the Bank of England (BoE) was forced to take emergency action to stabilise the UK bond market.

The Pound to Dollar (GBP/USD) exchange rate slumped to lows below 1.0550 before a powerful recovery to highs above 1.0900 as risk appetite recovered and the dollar retreated.

GBP/USD retreated to the 1.0800 area on Thursday.

After sharp losses to around 1.1030, the Pound to Euro (GBP/EUR) exchange rate strengthened to 1.1180.

During Wednesday’s European session, the Bank of England announced that it would intervene to buy long-dated gilts in the market to combat disorderly conditions. It will conduct daily operations to buy bonds until October 14th as the market had become dysfunctional and was posing a threat to financial stability.

The bank also announced that the scheduled gilt sales as part of the quantitative tightening programme would now be delayed until the end of October.

Gilt yields declined sharply after the announcement, although volatility remained very high. Sterling initially spiked higher before being subjected to renewed selling pressure amid underlying fears over the UK outlook and lower yields. Markets also scaled back their expectations of interest rates hitting 6% next year.

Although volatility remained extremely high, there was a net decline in yields on the day while the Pound eventually rallied strongly.

According to ING; “This was a necessary, temporary intervention to ensure the orderly function of the UK Gilt market - which our debt strategists describe as the 'bedrock' of the UK banking industry.”

The sharp drop in UK bond yields helped trigger a wider recovery in global bonds with a sharp decline in US yields on the day.

Lower yields helped trigger a rally in equities which also boosted the UK currency, but equities quickly retreated again on Thursday.

Wells Fargo Investment Institute, said markets may already be pricing in future pain, limiting the scope for further selling; "Should the economy slow and eventually fall into recession and inflation stays higher for longer, we believe financial asset prices have adjusted to reflect this likely reality.”

Barclays sees scope for short-term relief; “With most indices at fresh ytd lows, oversold conditions and sentiment uber bearish equities could stabilise or even bounce on any good news.”

Nevertheless it remains very cautious and added; “Absent a circuit breaker, the balance of risks for equities, particularly fundamentals, still looks skewed to the downside, in our view.”

S&P Global Ratings stated that it thinks the UK economy is already in recession which will last at least four quarters and sentiment remained extremely fragile.

DBS currency strategist Philip Wee commented; "Sterling is not out of the woods, the BoE is seen addressing the symptom and not the cause."

It added; "The government has yet to address the credibility of the tax cut plans, which critics see adding to the inflation woes."

ING added; “As we have been saying recently, trying to hold sterling together until the 3 November BoE rate meeting or 23 November fiscal update will be a tough challenge for policymakers.”

Commerzbank expects further reassurance will be needed with markets not waiting for November; “We see the urgent need for confidence building measures and as long as the government does not give in, this will include, first and foremost, the BoE’s clear commitment to hike rates significantly to limit the increasing inflationary risks due to the announced tax cuts, sterling weakness and the new bond purchases. Otherwise, sterling is likely to resume its downward trend quite soon again.”

Socgen also still considers government action will be crucial; "The ultimate resolution of the crisis requires fiscal, not monetary, policy action. Whilst the immediate firefighting is being done by the Bank, we must not forget that the crisis has been caused by the market's deep concerns about both the substance and the presentation of the new Government's fiscal policy."

Barclays remained very cautious over the outlook; "The currency is likely to be the easiest 'release valve' as investors come to terms with recent policy actions."

Standard Chartered added; "[The] BoE may have to hike rates to offer more sustained support to the currency."

Wells Fargo remains bearish on the GBP/USD outlook, especially with expectations of dollar strength. According to the bank; “With the UK still seen falling into recession and CPI inflation expected to peak lower than previously, we expect Bank of England rate hikes to fall well short of the Fed, or tightening currently implied by market participants.”

It adds; “We expect the pound to fall close to parity versus the US dollar over the next six months.”

According to Credit Agricole; "Our FX month-end rebalancing model signals that month-end portfolio-rebalancing flows are likely to be moderate USD buying across the board."

It adds; "Our corporate flow model further points to EUR selling at the end of the month.”

ING added; “expect cable volatility to stay high (one week realised volatility is a staggering 34%) and be beholden to any fiscal updates.”

BBH added; “We look for an eventual test of this week’s new all-time low near 1.0350.”

ING concluded; “we doubt cable holds gains to 1.08/1.09 and the bias has got to be for a 1.0350/1.0500 retest.”

Laurent Crosnier, global head of FX at European asset manager Amundi, commented; "We believe risks remain tilted to the downside – given how much is already priced-in, less aggressive signalling from the BoE will accelerate the move to below parity (for sterling/dollar), in our view."

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