Bank of England Faces A Choice Between Credibility and The Economy Says BNY Mellon

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The BoE's allusion to a possible rate rise is beginning to look like "policy error", according to one strategist, but if the bank rescinds its earlier guidance then bearish voices around Sterling will be amplified and losses magnified. 

Bank of England rate setters will need to choose between their credibility and possibility of calamity for the economy ahead of November’s keenly anticipated interest rate decision, according to currency strategists at BNY Mellon.

Much has been said, and even more written, about the health of the UK economy since Bank of England warned in September that it could soon begin withdrawing stimulus from the economy.

Meanwhile, BoE caveats including one that such a withdrawal will only occur if inflation moves further northward of its 2% target, have been lost amid the din of revised expectations and interest rate projections coming from research desks across the City.

“As we have argued, BOE allusions to a rate hike are beginning to look like policy error given the softening backdrop to the UK economy,” says Neil Mellor, a currency strategist at BNY Mellon.

Mellor and his team have written at length over the weeks about how, if it happens at all, a Bank of England interest rate hike wouldn’t do the fragile UK economy any justice at all.

“Whether the Bank proceeds with a hike for the sake of credibility, or retreats for the sake of growth, it is hard to make a convincing case for owning GBP right now,” Mellor writes, in one of his latest musings.

Mellor flagged in his earlier commentary that the construction industry is teetering on the edge of recessionary conditions while a sharp cooling of PMI readings for other key industries has also been observed. Car sales are falling while some parts of the housing market have also shown signs of softening.

He also cites more brazen commentary from analysts at S&P suggesting the BoE is jawboning the currency. Talking tough as part of an attempt to lift the currency and reduce imported inflation.

Whether it was jawboning or not, the Bank of England’s commentary on interest rates propelled Sterling to the top of the G10 basket during September.

“Now positioning is neutral and the bears are back in the ascendancy and are more inclined to focus on the Bank's assurances that normalization will be protracted,” says Mellor

Initially, the Pound-to-Euro rate saw its year to date loss fall from 8% to around 3% while the Pound-to-Dollar rate came near to achieving a 10% return for 2017. But throughout October, Sterling has fallen into a renewed pattern of retreat as concerns over Brexit talks and the economy have returned to the fore.

“The immediate problem facing Mr Carney is that if credibility dictates that the BOE must now raise rates in November, it risks compounding the present slowdown just as the Brexit negotiations reach a critical stage – thereby raising the prospect of a reversal of policy at some point,” warns Mellor.

One would think Mark Carney and his fellow policy makers might now be tempted to revoke their earlier guidance, in light of recent events. But, on the one hand, if the BoE rescinds its earlier guidance and stands still in November then the bearish voices around Sterling will be amplified and its losses magnified.

“Aside from the prospect of cable's continued descent towards 1.30, a BOE retreat could propel EUR/GBP back into the rarefied GBP 0.90-plus territory from which it has just escaped – developments that could easily unleash a new round of upward pressure on prices and a whole new headache for Mr Carney and Co,” says Mellor.

The Bank of England will announce its next interest rate decision on Thursday, 02, November.