GBP: Is the BoE trying to tell us something? - ING

There is a significant shift in BoE’s policy bias and it looks increasingly likely that it will hike interest rates sooner than many had previously expected thereby, impacting the futtre trajectory of GBP significantly explains Viraj Patel, Foreign Exchange Strategist at ING.

Key Quotes

 “Some removal of monetary stimulus is likely to become necessary if the trade-off facing the MPC continues to lessen and the policy decision accordingly becomes more conventional" - Bank of England Governor Mark Carney (28 June 2017)”

“This is a significant shift in policy bias – especially given that it was just over a week ago that Governor Carney told us that “now is not yet the time [to begin raising interest rates]”. One has to question the underlying rationale for this 'U-turn' and whether Bank officials have all of sudden seen some inflationary pressures in the UK economy that we have not. Even still, the Larry Summers approach to post-crisis monetary policy would suggest that allowing for some above-target inflation is not exactly a bad thing - given that it had been below-target for such a long period.”

“Nonetheless, last week’s BoE policy confusion – and what we described as a “cacophony problem” – has now been resolved and it looks increasingly likely that the BoE will hike interest rates sooner than many had previously expected. Markets have subsequently reacted with GBP up close to 1% against the USD and EUR.”

“Prospects of a “withdrawal of stimulus” – and the move higher in short-term UK rates – will underpin GBP in the near term. But our initial message would not be to overstate the implications of the Governor’s hawkish shift today; a reversal of the post-Brexit 25bp rate cut does not necessarily equate to a full-blown hiking cycle – especially given the tepid domestic inflationary pressures. For investors to start factoring in a Fed-like policy normalisation cycle in the UK, one would probably need to see a (permanent) uptick in wage inflation and a reduction in the long-run Brexit-related economic risks. Neither look all that likely in the near term (which again leaves us scratching our heads when it comes to the recent hawkish rhetoric).”

“GBP implications: With the UK OIS curve pricing in around 35bp-worth of BoE tightening by end-2018, any further BoE-driven GBP upside would seem unlikely. Our short-term GBP/USD financial model suggests that the pound is also no longer trading with any political risk premium – the 1.2950-1.3000 area looks “fair” after the recent hawkish BoE re-pricing. All of this suggests the risks to GBP are now much more two-way; it will only take a couple of weak UK data points for the current hawkish exuberance to fade and GBP to move back lower.”

“One could, however, argue that FX markets are to some extent "front-running" hawkish central bank rhetoric (which in itself is most policymakers' worst nightmare). As we saw in the EUR yesterday with the early follow-through buying after Draghi’s remarks, there are short-term risks that the GBP/USD rally could extend to technical resistance in the 1.3050/3100 area. That may mark the top for the time being; if not - and we see a daily/weekly close above 1.3100 - a more significant re-assessment of the BoE hiking cycle may be underway and 1.35/38 cannot be ruled out.”

“UK data to watch out for: The next UK labour market report - and the next update on domestic wage dynamics - will be out on 12 July. This - along with CPI (18 July) and the 2Q advanced GDP release (26 July) will be crucial data points to watch out for ahead of the August MPC meeting.”