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GBP: Inside the heads of the Monetary Policy

Thu, Jan 3 2008, 16:41 GMT
by John Hydeskov

Danske Bank A/S

• On 6 December 2007, the Bank of England (BoE) lowered the policy rate to 5.50% from 5.75%. The Monetary Policy Committee (MPC) voted unanimously for the proposition to ease monetary policy. The decision was based on the worsening financial turmoil and the consequent tightening of credit conditions as well as apparent signs of slowing growth in the industrial world.
  
• In this note we take a closer look at the factors impacting monetary policy in the UK going forward, including 1) Conditions in financial markets; 2) The international economy; 3) Money, credit, demand and output; and 4) Costs and prices. We will update our expectations for the UK policy rate in 2008 by using 1-4) and furthermore will use the lessons learned from previous policy decisions combined with our knowledge of the composition of the MPC. Finally, we will summarise the inputs on the forthcoming decisions on UK monetary policy in a revision of our GBP forecasts.
  
• We find that 1)-3) will weigh heavily on the rate-setting behaviour in the UK in 2008. The credit crisis is still not put to rest and will be the reason for the BoE to deliver a rate cut of 25bp in January and another rate cut of 25bp in February. Based on the outlook of conditions in credit markets, the global economy and some parts of the UK economy, we expect the BoE to lower rates by an additional 50bp over the year, taking the policy rate to 4.50% by the end of 2008. A continuation of the rise in energy and food prices will keep inflation above the BoE’s target in most of 2008 but will fall short of preventing further rate cuts.
  
• On the currency side, we expect GBP to weaken against EUR in the short term. Here we are more bearish on GBP than implied by forward rates. On the longer term we expect GBP to strengthen against EUR. Here we are more bullish on GBP than implied by forward rates. Our EUR/GBP three months forecast is 0.7550 while we see the pair around 0.7200 in twelve months time.

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Published on  Thu, Jan 3 2008, 16:44 GMT