|

The Bank of England Preview: With rates seen taking a nap in May, Sterling is set to suffer

  • The Bank of England is widely expected to keep the Bank rate on hold in May after the streak of disappointing macro data and with the Brexit uncertainty still haunting.
  • The policymakers are likely to voice the Brexit uncertainties and low productivity growth as main risks to the outlook.
  • The recent depreciation of Sterling reflects shifting divergence in the outlook for UK interest rates. 

The nine members strong Monetary Policy Committee (MPC) of the Bank of England (BoE) is expected to stand pat on the Bank rate in May leaving its outlook for the policy rate unchanged with three rate hikes warranted until 2020. With two arch-dissenter- Ian McCafferty and Michael Sauders - the vote decomposition is expected to stay unchanged from March at 7-2.
 
At the same time, the BoE is going to publish its May Inflation Report in which the short-term prediction for both growth and the inflation are expected to be downgraded as the effect of Sterling’s appreciation weighs on inflation while the UK economy exhibited unexpectedly strong deceleration in economic activity during the first three months of this year.

The shift in the outlook for the Bank rate changes in the environment of supposedly lower inflation and growth from current three rate hikes until 2020 will decide upon Sterling’s future with immediate effect. 
 
The  Bank of England Governor Carney admitted in April that “we have had some mixed data in the UK.” Although Carney refrained from being particular, his comment was a trigger of a massive re-evaluation in market expectations of the interest rate hike in May.  
 
While hard data like inflation and the wage growth came in slightly below expectations, the forward-looking PMI decelerated sharply in March and April indicating economic slowdown confirmed by lower-than-expected the first-quarter GDP. While some of the hawkish market participants expect the Bank of England hiking rates in August, given the statistical chances it is  November rate hike that makes a move a sure shot. 
 
The economic soft spot in combination with the US Treasury yields rising above psychological 3.00% level and rising disputes within the UK government over the issue of the Irish border or/and the customs union with the EU after the Brexit transitions passes resulted in Sterling falling nearly 900 pips in last two weeks against the US Dollar since the April’s 22-month high of 1.4377.
 
This 6% depreciation might not have a direct effect on the BoE’s main inflation target immediately, but the correction in Sterling eventually prolongs the path of the UK inflation returning to 2% target. 
 
While the UK needs stronger Sterling to dilute the adverse effect of rising inflation as early as possible to keep the household demand and wages stable and if possible in positive territory in real, inflation-adjusted terms, the economic softness of late and scaling back of the rate hike expectations resulting in lower Sterling have the opposite effect. What matters the most, is the pace of the appreciation/depreciation as the foreign exchange market effect on wages and inflation are long-term, and a lot depends on the extent of the move and its persistence. 
 
The Bank of England will also issue its May version of the Inflation Report, which is the key policy document regarding the macroeconomic framework of the UK economy. The May Inflation Report is expected to review the short-term outlook for both inflation and the economic growth downwards while consistently keeping Brexit and lack of labor productivity growth as the key risks of its outlook.
 
The UK inflation, 2008-2018


 

Author

Mario Blascak, PhD

Mario Blascak, PhD

Independent Analyst

Dr. Mário Blaščák worked in professional finance and banking for 15 years before moving to journalism. While working for Austrian and German banks, he specialized in covering markets and macroeconomics.

More from Mario Blascak, PhD
Share:

Editor's Picks

EUR/USD drops below 1.1600 on broad USD strength

EUR/USD stays under bearish pressure and trades at a fresh six-week low below 1.1600 on Tuesday. Despite stronger-than-forecast inflation data from the Eurozone, the pair struggles to stage a rebound as the US Dollar continues to attract safe haven flows amid escalating geopolitical tensions in the Middle East. 

GBP/USD attacks 1.3300, refreshing three-month lows

GBP/USD is deep in the red near 1.3300, accelerating its downside to renew three-month lows in European trading on Tuesday. The ongoing escalation in the Iran war, combined with rising Oil prices, weighs negatively on the higher-yielding Pound Sterling as the US Dollar capitalizes on increased haven demand.

Gold drops below $5,200 on stronger USD, rallying US yields

Gold attracts some intraday selling and falls below $5,200 on Tuesday. The US Dollar climbs to a fresh high since January 20 and turns out to be a key factor exerting downward pressure on the commodity. Meanwhile, the benchmark 10-year US Treasury bond yield rises nearly 2% on the day, putting additional weight on XAU/USD's shoulders.

Crypto Today: Bitcoin, Ethereum, XRP pull back as sentiment remains in extreme market fear

The cryptocurrency market is broadly in the red on Tuesday as the Middle East grapples with an escalating war. Bitcoin (BTC) is in a pullback, trading below $67,000 at the time of writing, and most altcoins follow suit.

Middle East conflict ramps up a gear as energy price spike rips through markets

It’s another risk off day as geopolitical headwinds continue to batter financial markets. Although markets calmed during the US session and US stocks managed to post gains on Monday, this has not fed through to the European session, and stocks and bonds are sharply lower for a second day.

Hyperliquid Price Forecast: HYPE rises on commodities demand amid US-Iran war

Hyperliquid (HYPE) steadies above $33 at press time on Tuesday, marking its fourth consecutive day of recovery in a broadly volatile market due to the ongoing US-Israel strikes on Iran.