The Bank of England Governor Mervyn King failed to signal that more QE is waiting in the wings for the September MPC meeting, which has helped the pound to be one of the strongest movers today along with the yen and the Swedish Krone.
King in upbeat mood
Although the Bank revised down the UK’s growth forecast, King’s message was seen as fairly upbeat for a couple of reasons: 1, the UK’s reported growth stats may show us having experienced three consecutive quarters of growth, however the actual rate of growth is probably stronger than that as a “number of erratic factors” like the Queen’s Jubilee bank holiday exaggerated the weakness of economic activity. 2, there could be a pick-up in consumption as inflation falls pushing up real household incomes. 3, the BOE/ government Funding for Lending Scheme (FLS), which came on line last month, should prompt a “gradual pick up” in economic conditions according to the Bank.
The message was not all rosy, however, and King also said that the UK’s level of output is not likely to surpass its pre-crisis level until 2014. Although King reiterated his comment that the outlook for UK growth remains “unusually uncertain”, and the Eurozone crisis remains a threat, at least he did not have deliver any “new” bad news.
More revisions to the BOE’s forecasts
King pointed out that employment growth remains “puzzlingly robust”, however he pointed out that inflation was kept in check due to fairly subdued wage growth. He also revised down the Bank’s May Inflation forecast due to lower energy prices; however he added that the outlook for inflation remaining at the 2% target rate is broadly balanced over the next two years.
So lower growth and inflation, this should mean more stimulative policy measures, right? No, not yet anyway. The Governor seemed to suggest that the BOE will wait until November before deciding on more policy support, which will give it time to see the impact of July’s QE boost and the Funding for Lending programme. November is when the Bank said that the impact of FLS on the economy should be known, it is also when the Bank release its last Inflation Report of the year and since the Bank has in the past chosen to adjust policy in the same month as it presents an Inflation Report, the market seems to have settled on the prospect of no near term support from the BOE.
Hoping the Funding for Lending Scheme makes some progress
The question now is if the Bank is correct to blame the UK’s weak growth on erratic factors, although the strength of employment and the fall in price pressures seem to support its decision. However, the Bank seems to be pinning a lot of hope on the FLS. In June M4 lending for banks fell more than 6%, added to that weak first half results for some of the UK’s big banks does not suggest that lending will pick up much for the rest of the year. Thus, the FLS will need to have a monumental impact on the economy for the Bank to put QE on the back burner in November.
We have spoken in the past that the Bank of England has run out of road. Its QE programme has arguably had a negligible impact on the economy and Gilt yields are already at record lows, so doing more QE could be pumping good money after bad. Thus, today’s report could be a tacit admission from Mervyn King that the only way to re-boot the economy is through fiscal policy – thus passing the baton to the government. If this is what King is doing then it has some interesting ramifications for the markets: 1, It could put a floor under UK Gilt yields, which is sterling positive 2, if the government’s fiscal stance is eased then it could threaten the UK’s credit rating.
UK Gilt yields rose on the back of King’s comments but have since retreated as Spanish bond yields are on the rise again. Essentially for as long as the Eurozone debt crisis is raging then there is likely to be safe haven demand for UK government paper.
Australian employment data is the highlight overnight.
One to Watch: EURGBP
Compared to Gilt yields the pound had a firmer reaction to the Inflation Report. It was up half a cent versus the dollar immediately after the report, and is currently getting stuck around 1.5650. While we could see some further strength maybe even to 1.57, investors are likely to book profits when they can until we get a clearer picture of how close the Fed is to more stimulus. We should know more after Bernanke speaks at Jackson Hole on 31st August. Until then we may be range bound in GBPUSD. A better cross to trade sterling strength in our view is EURGBP; it also had a big move lower post the Report, falling from 0.7950 to 0.7880. 0.7850 then to 0.7800 are major support areas. If Spanish bond yields continue to rise then EURGBP could head south. The daily RSI has also turned over, suggesting that the market not only sold the euro vs. the pound because of the less dovish than expected King, but also because the technical indicators suggested this cross was moving into overbought territory and was due a correction – using technical and fundamental analysis together.