What to expect from the BOE's Inflation Report

There is a double whammy of event risk for the UK on Wednesday. First up the employment data for June and July is released at 0930 BST/0430 ET, then one hour later Mark Carney will deliver the third Bank of England Inflation Report of 2014. The latter could give the market another steer on when to expect interest rates to rise. The former will be important to see if the labour market can continue to improve without creating wage inflation.

Wages have become a key data point for the BOE, and the June data is expected to show a 0.1% decline in wage growth over the last 3 months, leaving the annual rate at a measly 0.7%. Since the last Inflation Report the pace of wage growth has slowed, which could cause the BOE to err on the side of caution.

While we don’t think that Carney and co. at the bank will dismiss the prospect of rate hikes in 2015, we think this Report could quash prospects of a rate hike in 2014. Regarding the detail of the report, we expect the Bank to revise down its near-term inflation forecast as Q2’s CPI rate was 1.8%, which is slightly below the 1.9% forecast in the May Report. The Bank’s 3.4% growth forecast for 2014 could be revised higher, and if it is then we would expect 2015’s 2.9% estimate also to move to 3% or slightly higher.

The Bank’s unemployment forecast, which was 6.5% in May, is likely to remain in the 6-6.5% range, as the Bank could argue that the drop in the unemployment rate so far this year could start to slow if productivity picks up. If the Bank believes that productivity will rise then the unemployment rate forecast could remain virtually unchanged. However, if it still sees a lot of spare capacity in the economy this could present a problem for the BOE as it could push the unemployment rate down to a level that may be consistent with a rate hike; however wage growth could remain stagnant. If this happens, then BOE is likely to talk down the prospect of a near-term rate hike until further slack in the economy is eroded.

A confluence of factors is likely to weigh on the GBP this week. Risk aversion has seen it underperform in the G10 in recent wweeks, while safe haven currencies like the yen outperform. We expect the pound to be extremely volatile on Wednesday as the market digests the employment data alongside the Inflation Report. However, the technical picture is decidedly bearish and the weekly close below the daily Ichimoku cloud was a bearish development that suggests momentum has shifted to the downside. As we start a fresh week, if the BOE Inflation Report is less hawkish than expected then 1.6693, the low from 29th May, could come back into view.

This is our note from Monday, which is still relevant as we lead up to tomorrow’s Inflation Report.