Trading the BOE inflation report - EUR/GBP scenarios

Its Super Thursday again. The BOE rate decision and minutes along with the Quarterly Inflation Report (QIR) will be due for release tomorrow. No one expects the bank to move rates or alter its asset purchases tomorrow. The focus is on the minutes and QIR; both expected to throw light on the timing of the rate hike in the UK.

The degree of hawkish/dovish stance would be largely decided by –

• Vote count: 8-1 is widely expected by the markets. But, there exists a probability of another vote falling in favour of a rate hike - Kristen Forbes could join Mcafferty. Markets still believe the Fed would be the first one to hike rates and the BOE would eventually follow. At the moment, the consensus seems to be building in the markets that Fed has made up its mind to move rates in baby steps (10-12 bps) irrespective of the data. So the BOE too could follow the Fed in Q1 2016. Thus, a 7-2 vote count will be a hawkish surprise and appears likely as well.

• Inflation forecasts: Last month, the bank did state that weaker inflation since August was not entirely due to lower energy prices and said it expects inflation to remain below 1% until spring 2016. The downward revision of the headline inflation would not be surprising, however, a weaker core inflation forecasts would be a dovish surprise.

• Labor market: Service sector, manufacturing sector PMIs released this week showed the employment growth shot to multi-month highs. The unemployment forecasts could be lowered and Carney could indicate the labor market tightening is pushing inflation expectations higher.

• Wage growth: A positive commentary is expected on the wage growth, but it may not come as a hawkish development if the bank cites wage growth along with productivity growth (which does nothing to push up prices).

Meanwhile, a commentary on the Sterling could attract market attention if the strength in the exchange rate is blamed for ballooning trade deficit. Another not so important commentary will be a slowdown in the EM, external threat from EMs and falling energy prices.

Last month, the MPC stressed that a recovery in the Eurozone is keeping UK’s external risks limited despite slowdown in the EMs. However, the ECB hinted at more easing in December and killed the EUR/GBP rally.

Overall, the BOE events tomorrow are likely to carry a slight hawkish tone (possibility of 7-2 vote, but with a sharper downward revision of GDP/inflation forecast and negative comments on exchange rate) that will be enough to keep markets speculating that the rate hike will happen in next 6-months, while ensuring the Sterling does not rally significantly, especially against the EUR.

EUR/GBP – Daily Chart

Hawkish scenario

• A vote count of 7-2 and/or no change (lower) in inflation forecasts could trigger a drop in the EUR/GBP below 0.7030-0.70 handle, which shall open doors for 0.6950 (Aug 5 low)-0.69 handle. In case of a slightly dovish tone as discussed above: the oversold nature for the pair indicates the losses could be restricted around 0.7030-0.70 range.

Dovish scenario

• Meanwhile, a dovish tone (more gradual rate hike and lower growth/inflation forecast with 8-1 vote) could lead to a minor dip to 0.7063 (76.4% of July low-Oct high), followed by a recovery above 0.71 levels.

Larger inverted head and shoulder ahead in case of dovish tone/slightly hawkish tone?

The daily chart clearly says a turn higher from the range of 0.70-0.7070 could result in a formation of a larger inverted head and shoulder formation with neckline resistance around 0.75 handle. At the current juncture, such a sharp rally in the EUR appears difficult, however, it may happen if the equities turn risk averse ahead of the December Fed or the Fed delays rate hike.

Last month, a small inverted head and shoulder formation was breached, but failed to result in a rally after Draghi hinted at more easing in December.