BOE not so fast on rate hikes, as Broadbent keeps powder dry

The bond market seems fairly confident that the Bank of England is going to follow the Fed and raise interest rates, this explains why the 2-year bond yield is trading 25% higher than it was at the end of 2016. 2-year yields are now at 1.38%, significantly higher than the 0.25% BOE base rate. However, could the bond market be getting ahead of itself and is a reassessment of price action on the cards?

BOE may press pause on the hawkish rhetoric

We argue that the UK bond bears need to watch out. Firstly, although three members voted to hike rates in June, there is no guarantee that the number will rise further. Kristen Forbes, one of the dissenters, has now left the MPC and we don’t know if her replacement will vote the same way that she did. Also, although Andy Haldane, the BOE chief economist, and the Governor Mark Carney, have both sounded hawkish of late and raised the prospect of higher rates, neither have voted for a rate hike so far in their entire terms of office. Thus, we can assume that these two members will weigh up the economic risks before switching their vote to a rate hike, and with the economy starting to lose momentum they may choose to maintain the status quo for now.

Braodbent highlights BOE Brexit fears

Earlier on Tuesday we heard from deputy governor Ben Broadbent an influential member of the rate-setting committee. The market was eagerly awaiting his speech as it was the first opportunity to assess whether he would join the hawks and also vote for a rate hike next month. His speech in Aberdeen, the seat of the UK oil industry, gave no direct reference to his views on the outlook for UK monetary policy, however, he was very concerned about the UK’s trade prospects after Brexit, something that is most likely shared by the export-orientated audience in Aberdeen. It doesn’t seem like a stretch to assume that if Broadbent is concerned about Brexit’s impact on trade then he is unlikely to make things harder for exporters by voting to raise interest rates any time soon. Thus, the hawks on the committee, now just McClafferty and Saunders, could remain in the minority for some time.

Key test for GBP/USD

The next key test for the pound will be Wednesday’s UK labour market data. The market expects a decent rate of job creation for the three months’ to May of 120k, and the unemployment rate is expected to remain at 4.6%. It will be the wage data that everyone will be watching closely. With inflation up and wages down, the consumer squeeze is a key theme for UK asset prices. Wages for May are expected to fall to 1.8%, however excluding bonuses they are expected to rise to 1.9% from 1.7% in April. However, even if ex. bonus wages do rise to 1.9%, this would still be a weak level and well below the UK inflation rate. Thus, we don’t believe wage data is likely to be strong enough to justify a rate hike from the BOE next month, which could trigger a further unwinding of pound longs.

The next BOE rate-setting meeting is 3rd August, which is also an Inflation Report month. This is a crucial meeting; if the hawks can’t recruit more members to vote with them then a rate hike from the UK could be consigned to history. This is significant for the pound. When Haldane and Carney started to ramp up their hawkish rhetoric last month GBP/USD rallied from 1.25 towards 1.30. As the economy hasn’t kept pace with the rhetoric, cable hasn’t been able to hold onto gains above 1.30, and it has fallen back through a key 38.2% retracement level of support at 1.2863, this is the Fib retracement from the June 21st low at 1.26 to the June 30th high at 1.3030. Below here is a bearish development that opens the way back to 1.2811 – the 50% retracement level – and then 1.2769 – the key 61.8% retracement level, which is a key level of support for GBP/USD in the short term.