Pound Sterling sees Fresh Weakness on Bank of England Growth Forecast Cut

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The British Pound is seen falling ahead of the weekend as the losses inspired by the Bank of England's super-Thursday event run into a second day.

The UK currency fell on Thursday, May 11 after the Bank released the minutes for their May policy meeting while also releasing their latest set of economic forcasts. 

The forecasts revealed a downgrade to growth forecasts for 2017. 

It was however not all negative for Sterling as the Bank warned that despite an expected slowing in near-term growth they could raise their basic interest rate "by a somewhat greater extent" than markets are currently pricing in if its predictions of a continued pick-up in growth are accurate.

Indeed, while Sterling's initial reaction to the event was to fall, some analysts believe weakness will likely be temporary and a recovery is likely.

"A more positive economic forecast in the longer term could see Sterling bounce back once markets drill down into the detail," says Peter Ashton, Managing Director at Eiger FX.

However we believe that that the rally seen in Sterling since mid-March has been brought to a halt even if weakness proves temporary.

Pound Shows its Disappointment

The Pound's initial reaction to the Bank of England's super-Thursday event was to weaken as traders realised the Bank was not looking to provide the interest rate rises that are really required to trigger a sustained recovery in the currency.

The minutes to the May meeting reveals that only one member voted to rise interest rates and clearly traders were looking for another member to vote for a hike to signal the Pound should be bought.

Some had speculated on the basis of a recent speech that Michael Saunders might join Kristin Forbes and vote for a rate hike.

"This was in line with broad expectations, including our own forecast, although the confirmation that a second member did not join Forbes in dissenting meant that the Pound moved lower after the announcement," says Victoria Clarke at Investec.

kristin forbes BoE

Above: Kirstin Forbes, the single member of the MPC that voted for an interest rate rise. Pic Credit: Bank of England, Pound Sterling Live.

Moving on from the policy meeting, the quarterly Inflation Report showed a cut to the Bank's 2017 growth forecasts to 1.9% from the 2.0% previously forecast. 

Expectations for lower growth in worker wage packets over the near-term were also announced.

However, longer-term economic growth levels were revised higher which was seen as a positive and could well keep Sterling's losses contained to a degree.

Quarterly Inflation Report: Longer-Term Growth Revised Higher

Growth forecasts for 2017 were cut to 1.9% from 2.0% previously. But, 2018 growth is raise to 1.7%, up from 1.6% forecast previously, 2019 growth is raise to 1.8% from 1.7%.

So this is quite a positive development for Sterling longer-term and underpins that view that near-term weakness in the currency will likely eventually give way to a longer-term and more sustained recovery in the Pound.

Inflation for the final quarter of 2017 was raised marginally to 2.8%. The 2018 inflation forecast is lowered to 2.2% from 2.56% and 2019 inflation is lowered from 2.26% from 2.36% seen previously.

“The Monetary Policy Committee remained in wait-and-see mode this month, following slower growth in the first quarter, tepid wage growth and signs that household spending is coming under pressure,” says Rain Newton-Smith, CBI Chief Economist. “There are mixed messages on economic momentum, with survey indicators pointing to stronger growth than official data. Any changes to monetary policy are unlikely in the near future, particularly amid ongoing uncertainty over the impact and outcomes of EU negotiations.”

Anticipation had been growing in the hours running up to the release that the Bank will make a more positive assessment of the economy than previously expected - which would have been positive for Sterling.

The resultant details have however failed to suggest to traders that the Bank is on target to raise interest rates sooner than they had been expecting.

The Bank also expects real incomes will fall in 2017 as average earnings slow down more than previously thought.

Their forecasts show average weekly earnings only rising by 2% in 2017 as inflation peaks at 2.8% towards the end of the year.

Longer-term wage prices are however forecast to rise notably in the longer-term and this should place upward pressure on inflation.

And this should be positive for the Pound.

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"The Bank of England’s May Inflation Report lends some support to our view that interest rates are set to rise sooner than markets expect," says Paul Hollingsworth at Capital Economics.

Hollingsworth cites the Bank having nudged up its forecasts for 2018 and 2019 from 1.6% and 1.7% to 1.7% and 1.8% respectively.

Note that the MPC stated that interest rates may need to rise by a “somewhat greater extent than implied by markets” – the forecasts are based on rates rising in Q4 2019, although markets have pulled their expectations forwards to Q1 2019 in recent days.

"If we are right in thinking that the economy will maintain a solid pace next year, rather than slow as the MPC expects, then we think that the Committee should be in the position to take the first steps in “normalising” monetary policy around Q2 2018. All eyes are now on the press conference that begins at 12.30. After all, it is not uncommon for Governor Carney to strike a somewhat different tone to the text of the Inflation Report itself," says Hollingsworth.

Pound Tipped to Recover

There was some positive language around trade, exports and pay, with the MPC noting that given low levels of unemployment, “wage growth is expected to recover significantly”.

"But, and it’s a very big but, the Bank’s forecasts are predicated on a ‘smooth’ Brexit. With an election around the corner this is a clear message to the incoming government that working out a good deal with the EU is essential to future growth prospects," says Neil Wilson, market analyst at ETX Capital.

There is a slight tightening bias as the MPC said that if the economy follows its May projections then monetary policy might need to be tightened faster than the current yield curve in the market implies.

"A catalyst for a hike therefore might come from more robust consumer spending, particularly if wage growth really does pick up faster than we are seeing now. If this surprises to the upside over the rest of the year it could see growth exceed the Bank’s forecasts and this may let the hawks take a grip,” says Wilson.

For now the Pound has chosen to ignore this clearly bullish statement.

Richard Berry, founder of the currency specialists Berry FX, sees Sterling recovering back to levels it was at prior to the Bank of England event:

“The only surprise was the abject lack of surprises in the Inflation Report. Growth forecasts have been trimmed and the Bank expects inflation to continue creeping up – ensuring the MPC will remain impaled on the horns of a dilemma: to raise or not to raise interest rates.

“The Committee’s rate-setting grandees have once again voted overwhelmingly to hold, but the mood music is slowly changing to a more hawkish tempo.

“But this is all happening at a frankly glacial pace, and the realisation that any rise remains a distant prospect has led sterling to lose its fizz. Its gains from earlier in the week have largely been lost as the markets pore over the detail of the Inflation Report for inspiration.

“While the search for clues to the Bank’s thinking in the Governor’s press conference can resemble the guesswork of Cold War Kremlinologists, the hawkish tone should ensure that sterling’s losses are contained and that it ends the week about where it began.” 

While some recovery might be expected we do not believe that this recovery will yield fresh highs. To deliver fresh highs the Pound needed a game-changer from the Bank of England that hinted strongly at interest rate rises in the future. 

Without the support to UK gilt yields that such a hint would have provided Sterling the impetus for fresh highs will remain lacking.

At best the Pound can hope to bounce along near recent highs.


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