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Bank of England Won't Stand in the Way of the British Pound

Wed, Nov 19 2008, 14:31 GMT
by Kathy Lien

GFT

The British pound is on a tear even though the minutes from the most recent monetary policy meeting indicates that the BoE toyed with the idea of cutting interest rates by more than 150bp.

The markets are ecstatic about the Bank of England's proactiveness even if it means that UK interest rates will probably drop below 2 percent. Given the tone of the BoE minutes, we expect another 100bp rate cut at the next central bank meeting. The BoE is on a roll right now and the market expects big moves. Anything short of another 100bp rate cut could be a big disappointment. At the moment, the BoE is the most aggressive G7 central bank and expect the pound to join the ranks of the low yielders. However once the excitement dies down, we expect the pound to resume its weakness against the US dollar and Euro as the country closes its interest rate differential with the US dollar and the Euro.

Can you believe that the Bank of England considered cutting interest rates by more than 150bp at their last meeting. According to the minutes, they only limited the rate cut to 150bp and not 200 or 250bp because they were afraid of shocking the markets. As I recall, 150bp at that time was quite a surprise at the time! The decision was unanimous with all 9 members of the monetary policy committee backing the 150bp rate cut that took interest rates down to 3 percent.

Here are the specific reasons that the BoE gave for not easing more (in order of appearance in the minutes)

1. Uncertainty regarding fiscal policy

2. Desire to assess how measures to stabilize the financial system are working

3. Unwillingness to shock markets

4. Desire to retain some ammunition to support confidence in coming points

Point #1 suggests that we could see further fiscal stimulus by the Chancellor later this month. The UK government has gone above and beyond all of their G7 peers in trying to stimulate their economy, which should help speed up the recovery in the UK economy.

The MPC minutes also indicated that the BoE will not stand in the way of the British pound. The central bank wants to gradually ease interest rates (if 150bp can be seen as gradual) to limit the sell-off in the pound, so that it does not cause a sharp run up in inflation. Clearly, the BoE has no qualms about the 25 percent depreciation in value of the British pound against the US dollar and they are quite comfortable with further weakness in the currency as long as it is gradual.

Published on  Wed, Nov 19 2008, 14:31 GMT

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