As widely expected, the Bank of England voted to keep the base rate unchanged at 0.50% during last week’s meeting. The main surprise however, was on the minutes from the meeting (published at the same time as the rate announcement) which showed a 6-3 vote with the Bank’s Chief Economist, Andy Haldane joining Michael Saunders and Ian McCafferty in voting for a 0.25% rate hike. The overall tone of the minutes were deemed relatively hawkish with the committee sticking by its forecast that the economy will rebound in Q2 following a surprising blip in Q1 (which prevented the committee hiking in May).
At the beginning of last week, the market was pricing in a 50% probability of a BoE rate hike in August. This has now risen to 72% and was reflected in a rally in sterling against all its major counterparts. In the immediate aftermath of the announcement, GBPUSD rallied from 1.3110 to 1.3270 while GBPEUR rallied 1.1375 to 1.1460 (EURGBP fell from 0.8790 to 0.8725).
Chart 1 – Probability of a rate hike by August 2018
The Bank’s vote of confidence in the UK economy was good news for sterling from a short-term perspective, but it doesn’t detract from the fact that the MPC’s stance on monetary policy is relatively cautious. Sterling continues to face considerable headwinds from both macroeconomic and geopolitical headwinds. While headline inflation remains above the Bank of England’s 2% target, the MPC have shown a willingness in recent years to tolerate higher prices as long as there is a view that prices will revert back to target in the medium term. Given that Brent Crude has fallen around 10% from its recent highs above $80 per barrel and the biggest contributor to inflation in recent months has been increased input costs, the MPC are likely to remain comfortable for the time being.
At this stage, we agree that there is a high probability of a Bank of England rate hike in August. However, just as we were in May, we remain cautious of any sign that economic growth in the second quarter of 2018 is not rebounding as expected. The final readings for Q2 GDP will not be published before the Bank of England’s meeting on 2nd August (which coincides with the publication of the next quarterly inflation report) but the first reading (due on 10th July) should provide an initial gauge.
Furthermore, as Central Banks across the globe start talking about reducing the size of their balance sheet, the BoE also revised its guidance on QE stating that a portfolio unwind would not occur until rates reach closer to 1.5%. Given current rate projections, it therefore seems unlikely that the BoE will start selling assets before early 2020. One note of caution however for the long-term hawks; if the Bank does start reducing the size of its balance sheet, it may well put the break on additional rates hikes in the short term as this would constitute a tightening of monetary policy.
Whether we are talking short term (ie. focusing on August’s meeting) or looking longer term (ie. over the next 12 – 18 months) if it transpires that the Bank of England will delay raising rates again, sterling is likely to come under considerable pressure, particularly against the dollar if the Fed keeps tightening. For this reason, we retain our bullish bias for the dollar against sterling although note that given its recent advance on a trade weighted basis, the greenback is getting close to being in overbought territory and therefore remains vulnerable to a correction itself (as discussed a couple of weeks back).
Author: Marc Cogliatti