Is a change in the BoE’s stance good news for the pound?


During its last rate-setting meeting on the 15th of July, the Bank of England saw 3 out of its 8 members vote in favour of a rate hike. Even though most members were in favour of keeping rates unchanged, the vote hasn’t been this close in six years. To complicate things further, four days later the BoE’s chief economist Andy Haldane delivered a speech in Bradford showing he had converted from dove to hawk (even after voting to keep rates unchanged) mostly due to a stronger outlook for the world economy and the end to fears of deflation. His change was both a surprise to the market and a public disagreement with Mark Carney’s view that it is “not yet the time” to think about raising interest rates. Internal disputes aside, the BoE is not the only Central Bank who seem to be tipping the scales in favour of a more hawkish stance.

 

Since the financial crisis in 2008, we have seen unprecedented fiscal stimulus being injected into developed countries’ economies. Interest rates have reached the lowest levels we have ever seen (see graph below) and Central Banks’ actions have also extended to asset purchase programmes, living up to Mario Draghi’s famous quote “whatever it takes”.

 

 

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It seemed like monetary stimulus had reached its limits, but nonetheless up until now the Fed has been alone on its quest to reverse the trend. That doesn’t seem to be the case anymore. Over the last month:

 

 

One interesting aspect of these changes is that Central Banks appear to be more inclined to “look through” inflation readings and vote in favour of a normalisation of interest rates, which many analysts will say is long overdue. For the BoE, however, the challenge is to balance a slowing economy with high inflation (2.9 per cent in May, a four-year high) and the still unclear risks of Brexit.

 

From a currency perspective, a higher interest rate in the UK may balance (although not completely) the downside risks imposed to the pound by Brexit or accentuate the potential upside of a softer Brexit. However, if the ECB also begins to raise rates, the counterbalancing effect may be less relevant and might force the pound to depreciate against the EUR. Our GBP forecast remains neutral in the short term and bullish in the longer term (see our detailed thesis here), but we will keep a close eye on political and monetary policy developments that may justify a downgrade of these forecasts.

 

Author: Marilia Shewchenko



 

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