Markets, currently, are busy pricing-in a delay in the interest rate hike in the UK. However, there is an increased possibility that the Bank of England could actually turn dovish and may cut rates. Certain factors are already a hindrance to a rate hike, like–
1. Falling inflation – The data released by the ONS earlier this week showed the Consumer Prices Index (CPI) was unchanged in the year to February 2015, that is, a 12-month rate of 0.0%, down from 0.3% in January. This was the first instance of Zero inflation since records began. With energy prices more likely to slump further, the inflation year-on-year could very well fall below zero. A drop below zero supports Haldane’s comments that the bank could be forced to cut rates in order to battle deflation.
2. GBP at multi-year highs against the EUR – The diverging monetary policy expectations from the BOE and the European Central Bank (ECB) have pushed the EUR/GBP pair to multi-year lows. A strong Pound against the largest trading partner not only hurts exports, but also risks importing deflation. Moreover, the situation is unlikely to correct, especially since the ECB is purchasing EUR 60 billion per month. A hawkish Fed, as well as the delay in the US interest rate hike would both eventually result in a strong Pound. Thus, the BOE could be forced to turn dovish in the days ahead.
Risk of a hung parliamentMoreover, the need to turn dovish and actually cut the interest rates could rise further in case the general elections result in a hung parliament. The Confederation of British Industry (CBI) warned earlier this week regarding the negative effects of a “power vacuum” after elections. “"We cannot afford a power vacuum that delays urgent policy decisions and unsettles potential investors, so any new Cabinet must get down to business as soon as possible”, said the CBI.
Currently, the opinion polls suggest neither party is likely to have a clean sweep, which increases the possibility of a hung parliament. If we do have a power vacuum, the Bank of England may be forced to cut rates.
Delay in Fed rate hikeAnd lastly, the BOE could be forced to cut rates depending on how the Federal Reserve telegraphs its plans to raise rates. Post the last week’s dovish Fed statement, the markets have pushed out the rate hike expectations to September. Still, some believe the doors are still open for a rate hike in June. In case, the Fed turns further dovish in its April meeting, the markets are likely to erase the bets of a rate hike in 2015. In this case, the currency wars would pick up further forcing the Bank of England to cut rates. Moreover, the delay in Fed rate hike would further strengthen the Pound against the Euro.
The GBP/USD pair faces the risk of falling to 1.42 levels in case the BOE turns dovish and starts hinting at a possible rate cut.
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