The dollar has extended gains in recent sessions. It is not because of any fundamentally positive change but because the buck is the best of a bad bunch.
Earlier in the week the Aussie dollar dived as the RBA opened the door to easing. Overnight the New Zealand dollar experienced its worst day in a year after a weak employment report. Today attention switches to the BoE and the pound.
No change to policy expected
The BoE is widely expected to keep policy unchanged when it makes the announcement at 12:00 GMT. The central bank is also expected to lower the already lackluster growth forecasts as Brexit uncertainty continues to weigh on the economy; a reflection of the fact that there is still no deal in place with just 50 days to go until Brexit.
Given that there is no transition deal in the bag, the BoE’s options are limited. The direction of the UK economy and monetary policy depends firmly on what type of Brexit the UK achieves, an orderly exit or disorderly.
With Brexit clouds limiting the BoE’s vision and therefore options, anything other than a wait and see approach is not viable. Theresa May is still scrambling to get further concessions, whilst European Council President Donald Tusk couldn’t have made himself clearer; there will be no new proposals to replace the Irish backstop arrangement. We expect the BoE to continue to warn over the economic consequences of a no deal Brexit. But to say that it is not the expected path. The central bank will also stick to the one hike per year song sheet.
Growth trimmed in quarterly inflation report
With the BoE’s hands tied on monetary policy, the quarterly inflation report is much more likely to catch trader’s attention and move the pound. The BoE will have two contradictory trends to consider relating to its principal policy target, inflation. Firstly, declining oil prices from the oil slump in Q4 of 2018 easing prices at the pumps although this could be considered short term. Meanwhile wages growing at the fastest pace in a decade whilst the labour market continues to tighten will lift inflation prospects and is fundamentally more important to the BoE. In November the BoE saw inflation remaining just above 2% for the next two years.
The BoE said it expected growth to hit 1.7% in 2019, 2020 and 2021. After lead indicators have weakened significantly over recent months and given signs of a global slowdown, we expect the BoE to trim growth forecasts. This could dampen demand for the pound. The next quarterly inflation report is in May, when Brexit should also have been decided one way or another. In the case of a Brexit deal, May would be the prime candidate for a rate rise.
The pound has slumped below support at $1.30 as Brexit hits sentiment from all sides. There, is no solution to Brexit in sight, the UK economy is suffering under the strain of Brexit and there is talk of extending the uncertainty. A dovish Carney adding to the pound’s woes, could send it tumbling towards $1.28.
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