80% Chance of ‘Hawkish Risk’ for Pound / Dollar Rate on Bank of England’s Super Thursday

One analyst describes Thursday’s Bank of England event as a “colossal risk event for sterling” - we would agree that it is a risk, but colossal may be a little extreme.

Nevertheless, this is a nuanced event for those with an interest in the British pound, whether a trader or someone who has notable foreign exchange purchases to consider.

It is with this in mind that we bring you the ‘cheat sheet’ on navigating the currency markets on Super Thursday.

Thanks go to James Rossiter, Senior Global Strategist (pictured) and Renuka Fernandez, Senior Rates Strategist at TD Securities for the following:

What: The Vote Count

A 9-0 vote seems the safe thing to do with the EU Referendum just 43 days away. But two MPC members have said a deterioration in the data might push them to vote for a cut. This is highly unlikely (they’d likely reverse by late-summer), but not impossible: just last month the MPC said they’d look through any near-term weakness in the data.

What: The Inflation Forecast

The inflation forecast will need to incorporate the move up in oil prices from the Feb IR’s $37/bbl 2016 assumption, which will boost this year’s inflation forecast. Rate expectations have fallen since Feb, so if the MPC incorporate yields below 0.50%, this should boost the Year 3 inflation forecast to a record high above 2.25%.

Latest Pound/Euro Exchange Rates

	Live: 1.1455▲ + 0.1% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1066 - 1.1111
**Independent Specialist	1.1295 - 1.134 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

What: The Growth Forecast

The inflation forecast will need to incorporate the move up in oil prices from the Feb IR’s $37/bbl 2016 assumption, which will boost this year’s inflation forecast. Rate expectations have fallen since Feb, so if the MPC incorporate yields below 0.50%, this should boost the Year 3 inflation forecast to a record high above 2.25%.

What: The Labour Market

The inflation forecast will need to incorporate the move up in oil prices from the Feb IR’s $37/bbl 2016 assumption, which will boost this year’s inflation forecast. Rate expectations have fallen since Feb, so if the MPC incorporate yields below 0.50%, this should boost the Year 3 inflation forecast to a record high above 2.25%.

What: EU Referendum

We will closely examine Carney’s responses to inevitable questions about a rate cut. 2016H2 is a binary outcome for growth, and monetary policy will respond quite differently in each scenario.

What: Wages

Carney and other MPC members continue to focus on costs and productivity in relation to the first rate hike. It’s likely he’ll suggest cost pressures still give time to wait.

What: GBP

Sterling has depreciated sharply, much of which the Governor will attribute to referendum uncertainty. But it does help inflation in the near-term.

What: Yield Curve

Markets have priced in 12bps of rate cuts for this year. Governor Carney will likely push back against this, emphasising the Year 3 inflation forecast.

Risks and Currency Reactions

Dovish Risk (15%):

A dissent or two favouring a rate cut amid broader data weakness, or evidence in the summary / IR that (still very fresh) weak survey data is being caused by more than just EU Referendum uncertainty.

Downside risks for the GBP to USD. Look for a test of support at 1.4310.

On rates this will add fuel to the current rise in Brexit premia, however levels are already very stretched. 2y gilts could fall back down towards 0.32-0.35%, 10y towards 1.32—1.35%.

Hawkish Base Case (80%):

If the MPC plays it safe then markets might interpret the fact that they “ignore” the recent weak data as hawkish.

A small upward revision to the inflation forecast on lower yields and only a tiny downgrade to near-term growth would be interpreted by markets as mildly hawkish, reinforcing the MPC’s view that yields have moved too low.

Modest retracement of the move off the recent cycle highs for GBP/USD. We target a challenge of resistance at 1.4543.

On rates we should see some retracement as levels are very stretched, 2y gilts back up towards 0.4%, 10y back in 1.40-1.50% range.

More Hawkish Risk (5%):

A sizeable upward revision to inflation at the Year 3 point, or mention that excess demand might build with the current yield curve. A vote for a hike is very unlikely.

A sharper short squeeze in GBP/USD would see a move toward resistance in the 1.4580/90 zone but 1.4640 should cap.

On rates, yields should shift higher across the term structure as levels are very stretched. 2y gilts towards 45bps, 10y 1.55-1.65% range.

Any mention of rate paths post-Referendum will have implications for markets.

A mention of a cut if Leave win will depress yields, though a reminder that if Remain win, them next move in rates will likely be up may have limited upward pressure on rates (if markets don’t believe him).

The broader trend for GBP/USD is lower, but we are due for some upward correction soon.

This should be used as an entry point for strategic shorts ahead of the referendum.

UK rates are very stretched at current levels, the mention of cuts if Leave wins could push hike expectations to late 2019. The talk of hikes in the event of Remain