GBP: How cornered is the BoE? - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, notes that in September, GBP was the best performing G10 currency on the back of the step up in hawkish commentary from the BoE and in their view the recent rate hike warnings from the MPC are rooted in the outlook for GBP. 

Key Quotes

“The stabilising of sterling therefore suggests that the BoE’s verbal interventions have thus far been a policy success which could potentially reduce medium-term inflationary risks.  However, the better tone of the pound was on the back of market expectations that the BoE would hike rates as soon as November.  If the MPC backs away from this position, Governor Carney may again face accusations that he is behaving as an ‘unreliable boyfriend’ and the Bank could face a credibility issue.  However, if the Bank makes the unusual decision of hiking rates at a time when there are clear signs of a slowing economy, the Bank’s credibility may also be questioned.  This would imply the support that the BoE has recently afforded the pound could prove to be short-lived.”

“Last Friday, the annual pace of UK GDP growth in Q2 2017 was revised lower to 1.5% y/y. Not only is this the UK’s weakest annual growth rate since 2013 but it contrasts with the hastening pace of activity in the Eurozone.  The UK’s quarterly increase was left unchanged at 0.3% q/q.  However, the only sector to contribute positively to quarterly growth in Q2 was services.”

“Agriculture, production and construction all posted negative contributions.  The vulnerability of the construction sector was underlined again this morning by the unexpectedly drop in the September construction PMI to just 48.1.  Within services the largest contribution to Q2 quarterly growth came from the distribution, hotels and restaurants subsector and within this the best performing area was retailing (excluding motor vehicles).  The Office of Nationals Statistic simultaneously reported last Friday that there was a slowdown in household spending in Q2, driven by a decline in the purchase of motor vehicles.  Going forward, this sector is likely to more broadly feel the impact of the sustained increase in the CPI inflation rate and the resultant downward pressure on real wages.  This is a sizeable risk to economic growth going forward.”

“When real incomes are in decline consumers have the option of increasing borrowing or using savings to subsidise income. However, this is unlikely to be possible for many UK consumers.  In 2016, the UK household savings ratio was 7%.  In Q2 2017 this was running at just 5.4%.  Compared with other European countries this is low.  In the same period Germany’s savings ratio stood at 17.1% and France’s was 14%.  The implication is that UK consumers have less raining day funds to fall back on than their Eurozone counterparts.   Simultaneously levels of household debt in the UK are at elevated levels meaning that many households will not be able to increase borrowing further to buoy their expenditure.  Not only does this bode poorly for overall consumption in an environment of falling real wages, but it also suggests that an increase in BoE interest rates is likely to be felt as a double whammy by many households.”

“The implication is that the BoE are unlikely to be able to hike interest rates very far in months ahead.  Although a BoE rate hike in November or in February may remove some downside potential for sterling, if the market assumes that the BoE are then likely to sit on their hands for an extended period, the pound is unlikely to see much sustained support.  Indeed, once political uncertainty is layered on top of UK growth concerns, we see scope for the value of GBP to soften medium-term.”

“The UK’s Tory Party conference started in Manchester over the weekend as the divisions within the party grow increasingly evident. PM May had hoped to use this week as an opportunity to rally the party behind her.  However, Foreign Secretary Boris Johnson has again outlined his views with respect to Brexit, resulting in May having to field questions over the weekend as to why she has not sacked him.  Speaking through last Friday’s addition of The Sun, Johnson outlined his four Brexit “red lines”.  These include the transition period being a maximum of two years.  This point has been countered by Chancellor Hammond who has since indicated that a transition period could be longer than 2 years.”

“The squabbling within the Tory party and the lack of progress on Brexit talks are both set to weigh on the pound going forward.  Comments from President of the EU Juncker this morning that Brexit negotiations were still not advanced enough to be ready to move on to future arrangements confirm that the chances of trade talks starting this month are negligible.  We see EUR/GBP as slipping back towards the 0.90 area around year end and pushing towards 0.95 next summer.  These forecasts assume that the pace of Brexit talks remain slow and that UK firms continue to put contingencies for a hard Brexit into position.”