The hawks at the Bank of England have started to spread their wings. At last two members of the Monetary Policy Committee (MPC) have broken ranks with the Governor for the first time since 2011. The longest period of unity in the MPC’s history has been shattered, now things at the BOE will start to get interesting.
The fact that two members have voted for a rate hike already is significant for a few reasons. Firstly, Martin Weale has always been on the more hawkish side of the fence, whereas Iain McCafferty was typically more neutral. If Weale was able to convince McCafferty to vote for a rate increase could he secure four more votes in the coming months, which would be enough to push through a rate hike? Secondly, once members change their vote they tend to stick to their position. Thus, we doubt that Weale and McCafferty will switch back to voting with the Governor anytime soon. Lastly, the August MPC meeting included the two new members including Kristin Forbes and Nemat Shafik. The tone in the minutes was notably more neutral than in recent months, which suggests that these two could be contenders to raise rates if the economic recovery continues. The split suggests that the MPC is not as dovish as Mark Carney, the Governor, which could mean future decisions are on a knife edge, especially if the economic data continues to improve and wages pick up.
What about inflation?
This meeting was held before we got the latest inflation data for July, which showed that prices had fallen to 1.6%, and producer prices had declined to their lowest level since 2009. The MPC noted that inflation pressures could rise in the coming months on the back of any escalation in tensions between Russia and Ukraine, which could have a material impact on commodity prices. However, since the meeting the two sides look like they are trying to reach a truce and oil prices have declined further. If prices continue to fall this could make other members cautious about taking the plunge to vote for a rate hike, especially since stable prices are the MPC’s only mandate.
Do Weale and McCafferty care about wages?
So why did Weale and McCafferty vote for a rate hike this month even though wage growth fell for the first time since the financial crisis? The minutes note that both members believe that the rapid fall in unemployment, combined with survey evidence of tightening in the labour market “created a prospect that wage growth would pick up.” The two members also believe that wage pressures could start to build with a lag, since monetary policy also impacts the economy with a lag; they felt it was desirable to “anticipate labour market pressures by raising Bank Rate in advance of them.”
While the other members decided to remain on hold, the minutes note that an over-reaction in financial markets was not necessarily a reason to delay an increase in Bank Rate “if that were merited by the economic data”. Thus, even if we get further flare-ups of geopolitical risks, the Bank of England may hike anyway.
Rate increases vs. Inflation
For now, inflation could be the biggest hurdle to the future trajectory of rate increases. The next round of wage growth data is due out on 17th September and will be watched closely for any signs that strong wage growth is boosting wages.
The market impact:
After an initial bout of volatility that saw GBPUSD test its 200-day sma at 1.6677, the follow through has been disappointing, even though the minutes suggest that the UK is closer to a rate hike than what the Inflation Report seemed to suggest. The pound is being stymied by the dollar, which is on a rip higher today, and the dollar index is above 82.00. While the minutes are helping to protect the downside in GBPUSD, whether or not we get a recovery in cable could be dependent on Janet Yellen later today. If she is less hawkish than some expect during her opening speech at the Jackson Hole central bankers’ conference, we could see the pound start to price in the impact of mutiny at the BOE.
The technical picture: GBPUSD looks vulnerable
After Tuesday’s fresh lows there is scope to extend the recent decline, especially if Fed chairwoman Yellen talks about the potential for tightening once the Fed’s tapering comes to an end in October. Key support levels include: 1.6556 then 1.6460 – the respective lows from April and March. If, in due course, these lows give way then we could test critical support at 1.6284 – the 38.2% Fib retracement of the July 2013 – July 2014 bull trend. See chart below.
If, Yellen does not deliver the hawkish goods that the market expects, then watch out for a daily close above 1.6677 – the 200-day sma, which would be a bullish development for GBPUSD and may open the way to 1.6800.
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