Bank of England’s August 4th Decision - The Big Upside Risk to GBP is No Cut

All eyes on August MPC meeting

The British Pound is being driven almost exclusively by expectations for a policy announcement from the Bank of England at their August 4th meeting - but what should you expect?

The British Pound has struck a sideways tone against the likes of the Euro and US Dollar over the course of mid- to late-July, and the reason for this is understandable.

A big decision from the Bank of England looms, and taking a big position on Sterling ahead of such a decision would be foolish.

The Bank of England is now the single most important factor for Sterling’s outlook as the policy measures will impact directly on demand for UK assets, particularly bonds.

Should an interest rate be announced then we would expect demand for UK debt to diminish as the yield offered to international investors is cut.

This source of inward funding is needed to keep the GBP at elevated levels; removing it would prompt a necessary downward reduction.

Since the Bank of England’s Martin Weale came out and said he would now support a rate cut, the British Pound has traded with a heavy tone with analysts seeing this as a sure sign that action is coming.

Arguably, a 0.25% cut is now fully priced into GBP.

Therefore, anything more, or less, will likely spark a notable currency reaction.

The big deal for foreign exchange markets then is how expectations are met and missed.

But, the event will be more nuanced than being a binary bet on a 0.25% cut, and to aid readers in building a picture of expectations, we bring the latest views from those professionals who have a pretty good idea on what to expect.

Asset Purchases and a Cut Coming: Capital Economics

Analysts at Capital Economics have told clients that they now expect the UK economy to enter a period of stagnation and rule out the prospect of a recession.

A stabilisation in post-vote confidence is a leading reason for the call.

"Another reason why we think the effect of Brexit on the economy won’t be too severe is the response from policymakers," says a note from Capital Economics.

Markets’ implied probability of a rate cut at next week’s MPC meeting has risen to 100%!

"We agree with market expectations that Bank Rate will be cut by 25bps next week and we also think the MPC will announce an increase in the Asset Purchase Facility (i.e. QE) of £75bn," reads the note.

No Change Warranted: Accendo Markets

Mike van Dulken, Head of Research at Accendo Markets notes that, "pretty much everyone expects stimulus via more QE (up from its last monthly amount of £50bn in 2012) and maybe even widening the scope of assets to include corporate bonds given how overbought and low yielding UK gilts have become."

On the question of a rate cut, van Dulken notes:

"Many believe a rate cut is also on the cards but we see good reasons not to bother.

"Firstly would it really help, given how low rates have been since the FTSE bottomed in March 2009? Will it make anyone more likely to spend/invest? Secondly, why inflict more pain on the banks, especially the bailed out Lloyds which the government still holds a 10% in and is desperate to unload but unable to while the shares languish 20p offside?

"A rate cut won’t help the share price its profitability is dented by further squeezing still depressed Net Interest Margins. Don’t do it Mark. It’s not worth it."

No Change: Swissquote

Perhaps the most surprising view comes from Arnaud Masset at Swissquote Bank.

Masset says because the BoE will only be able to cut interest rates a couple of times before reaching negative rates, it will likely opt keep its powder dry.

“The BoE has limited room for manoeuvre before switching to negative interest rates. Therefore, we expect the central bank to leave its benchmark rate unchanged at its next meeting on August 4th, waiting for further information about the implication of Brexit for the UK economy,” says Masset.

If Masset is right expect a sharp pop higher in the British Pound as those 100% expectations for a rate cut are rapidly unwound.

On the other hand, says Masset, the BoE could increase the target for asset purchases without cutting rates.

Lloyds Bank Commercial Banking: Stimulus to Fall Short of Shock and Awe

Also striking a potentially pro-GBP tone are Lloyds Bank who reckon any policy changes will almost be tentative in nature.

Lloyds expect at 25 basis point cut to the interest rate, but note “reductions in Bank Rate may expose banks and building societies to increased interest margin pressure.”

As such, Lloyds’ Michael Sawicki says he expects the Bank of England, in conjunction with the Treasury, to deploy a revamped Funding for Lending Scheme that provides a partial offset, channelling cut-price central bank money in targeted credit easing to the real economy.

Sawicki notes further:

“Remarks from the MPC’s Kristin Forbes seemed to rule out policy easing until ‘hard’ figures emerge that could better inform the impact on the economy. As such, we expect an 8-1 or possibly 7-2 vote to carry through the 25bp Bank Rate cut.

“The more pertinent question is whether the MPC will be able to mount a more ‘prompt and muscular’ response, as hoped for by BoE Chief Economist Andy Haldane in his speech of 15 July.

“The absence of support for a big move in July, including from Haldane himself, suggests that due consideration is being given to the size and calibration of the stimulus package.”

UniCredit: Watch out for Disappointment

Daniel Vernazza, Lead UK Economist with UniCredit Bank in London says his team expect the BoE to announce a 25bp cut to the bank rate and a boost to its Funding for Lending Scheme, but no increase in its stock of asset purchases.

“Since financial markets are fully pricing in a 25bp cut and some expansion of asset purchases, market participants may be disappointed,” says Vernazza.

Like Lloyds, analysts expect the BoE to announce a “package” of easing measures, including a 25bp cut to the bank rate and a boost to the Funding for Lending Scheme (which subsidises lending to the real economy but is currently only on SME lending and is due to expire in January 2018).

UniCredit expect the Committee to vote 8-1 in favour of cutting the bank rate.

ING: Base-Case and Risks

ING's base case for the August MPC meeting is:

(1) a 25bp rate cut;

(2) an initial £50bn expansion of QE asset purchases (mainly conventional gilts); and

(3) the announcement of further credit easing initiatives such as the Funding for Lending Scheme (FLS).

But, analysts also see risks of a dovish BoE surprise:

"With a 25bp rate cut all but priced in, any dovish BoE surprise next month is more likely to come from an announcement of a larger-than-anticipated QE expansion.

"We think the balance of risks lie to the upside on our £50bn QE call given that: (a) the post-Brexit uncertainty shock may turn out to be larger than predicted; and (b) the stock of eligible gilts does not provide any material buying constraints."