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The Pound Jumps vs. Euro and Dollar as Bank of England Points to August Rate Rise: Currency and Analyst Reactions

- Pound Sterling charges higher on Bank of England minutes

- Analyst says minutes doctored to specifically support the Pound

- Eyes turn to Mark Carney's appearance at the Mansion House this evening

Bank of England MPC

Bank of England Monetary Policy Committee © Elif Miotti

At its meeting ending on 20 June 2018 the Bank of England MPC voted to maintain the basic Bank Rate at 0.5%, in line with market and analyst expectations. Minutes to the meeting show the decision carried by a majority of 6-3.

The vote balance was a surprise however; we warned ahead of the event that should more than two members of the MPC vote for a rate rise this would be taken as an early bullish indicator for Sterling.

Indeed, the reaction by Pound Sterling confirms this to be the case:

The Pound-to-Euro exchange rate was quoted at an high of 1.1458, up from the day's low at 1.1362.

The Pound-to-Dollar exchange rate is quoted at an high of 1.3270, up from the day's low at 1.3102, indeed GBP/USD saw its 3rd biggest one-hour rise of 2018, the largest since February 14.

"A 6/3 vote for a market expecting 7/2, a taper to kick in at 1.5% down from 2% and the MPC considering the economic slowdown to be temporary are all bullish signals for GBP. Certainly these factors are pushing the Pound much higher," says Neil Jones at Mizuho Bank Ltd.

Chief Economist Andy Haldane was shown to have joined Ian McCaferty and Michael Saunders in swinging the Committee closer towards a vote rise and suggests the potential for a rate hike at the August meeting has grown.

"Haldane is an important guy in the BoE, so him voting for a hike sends a powerful signal.  If he had the power to move rates around himself and someone held a gun to his head, given all that is going on in the world now, do you think he'd actually raise rates today? I don't. This set of minutes looks quite doctored up to me in order to shore up Sterling and provide a bit of support to rates," says Stephen Gallo, head of European FX strategy at BMO Capital Markets.

This is an interesting take on the matter and suggests there might be a good deal of market strategy at play at the Bank.

However, other analysts are inclined to give the Bank a benefit of doubt and suggest data and data expectations are moving in a direction consistent with today's message and it would appear that expectations for robust wage growth in particular is largely behind the Sterling-positive outcome:

"Those voting for a hike noted there appeared to be an upside risk to the Bank's wage growth forecast. Leading indicators suggest wage growth will continue to outpace the MPC's forecast of 2.75% for the year as a whole," says a flash comment from Capital Economics who expect the Bank to raise interest rates in August.

Bank to raise rates in August

 

Graphic courtesy of Berenberg Bank

Another key takeway is the news that "the Committee intends not to reduce the current stock of purchased assets until Bank Rate reaches around 1.5%." Right now all assets bought under the Bank's quantitative easing programme are allowed to roll over on expiry ensuring the holding of assets at the Bank remains constant. The stock of purchases will be reduced when the Bank allows them to expire; this is what the US Federal Reserve is currently doing, and this creates a tightening of money supply in the economy.

"Whilst the general tone of the minutes was that future tightening is likely to be gradual and limited, there was a noted change in stance on asset purchase cutbacks being considered when the key rate reaches 1.5% - down from 2% previously. The Pound erased intra-day losses to trade a cent higher versus the Dollar on the news as the hawkish move from MPC’s Chief Economist suggests momentum building for an August hike,” says Nish Parekh, Senior FX Trader at Silicon Valley Bank.

 

Sterling Higher

The move higher in Sterling is consistent with the forecasts of those analysts included in our preview piece, published last night and updated this morning.

BMO's Gallo was one of those analysts who got it right in calling the relatively hawkish set of MPC minutes, he said the outcome would likely trigger a move higher in GBP/EUR and he liked the idea of playing the 0.87/0.88 range in EUR/GBP as a result.

The EUR/GBP range of 0.87 /0.88 gives a range of ~1.15/1.1360 in GBP/EUR terms.

Back to the top of the range for the Pound to Euro exchange rate

BMO Capital have been saying for months that the BoE is on a gradual normalisation path; "but the market for the GBP has been so depressed, that it has taken another (quite important) MPC official to vote for a hike in order to turn things around a bit. The message is clear: the BoE is not shifting off a normalisation path so don't get too bearish on the GBP."

"We think the MPC will look to avoid perceptions that it is shifting to a more dovish stance... the MPC has little reason to encourage a further extension of GBP weakness," says Gallo.

The value of the Pound matters for the Bank who are tasked with targeting inflation at around the 2% marker: a weaker Pound means imported inflation rises as the cost of imports increases.

Therefore there is some benefit in maintaining a stable currency and Sterling's recent slump against the Dollar will certainly be noted by the Bank.

"From a cost perspective the minutes confirmed that the strengthening in global energy prices implied a firmer CPI profile over the next six months, a trend which would be reinforced if Sterling’s recent weakness were to persist," says Philip Shaw with Investec in London.

"We look for the range lows near 0.8680 in EUR/GBP to provide support," says Mazen Issa, Senior FX Strategist with TD Securities, referencing a potential resistance target of 1.1520 in GBP/EUR. However, Issa says he is cautious in extrapolating too much of a directional impulse out of this story as "the short Sterling curve's adjustment looks appropriate."

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Analyst Reactions

"We think the BoE will need to see three developments for a hike in August: 1) a sustained rebound in real GDP growth to at least the BoE’s estimated potential growth rate of 1.5% annualised yoy; 2) nominal wage growth at close to or above 3% yoy (currently 2.8%); and 3) survey measures that continue to point to rising underlying inflation and falling spare capacity." - Kallum Pickering at Berenberg Bank.

"The MPC’s vote and minutes are more hawkish than we had expected and keep alive the chances of an August rate hike. The Committee continues to think that “an ongoing tightening of monetary policy” is required, suggesting that it doesn’t expect to wait much longer before raising Bank Rate again. The minutes repeatedly gloss over weak data that have been published since it last met." - Samuel Tombs at Pantheon Macroeconomics.

"Today's decision strengthened the case for a rate hike in August. For now, however, we stick to our forecast that the Bank of England leaves its policy rate unchanged throughout 2018 and 2019. We expect a bleak economic development going forward which, coupled with the fading inflationary boost from currency development, will hold back inflationary pressures." - Andreas Wallström at Nordea Markets.

"We doubt that the MPC will sit on its hands for too much longer. Provided that GDP growth rebounds and earnings growth strengthens as we expect, we remain confident in our view that the next rate hike will come in August, with another following in November." - Ruth Gregory at Capital Economics.

"We continue to expect the MPC to remain on hold through this year since we expect growth and inflation to be weaker than the MPC expects, and for heightened Brexit-related uncertainty to persist. The risk that the MPC hikes already later this year, and possibly as soon as August, have increased following today’s MPC minutes but, in our view, if the MPC were to hike it would likely prove a policy mistake." - Daniel Vernazza at UniCredit Bank.

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