- Sell the GBP ahead of BoE meeting say Nordea Markets.
- BoE will not raise rates this Thursday despite market expectations.
- Inflation, wage pressures are in retreat and a hike is not justified.
© Pavel Ignatov, Adobe Stock
Strategists at Nordea Markets say Sterling will almost certainly be found wanting after the Bank of England interest rate announcement, set for Thursday, August 02 and they therefore recommend selling the currency.
The Bank of England is widely expected by the market to raise UK interest rates to 0.75% at 12:00 London time Thursday, so meaningful upside for the Pound would only come if the BoE were to signal that further interest rate rises are in the pipeline for later this year or next.
Financial markets see the prospect of further rate rises as slim given a steep 2018 fall in inflation and an anticipated increase in political and economic uncertainty relating to Brexit toward the end of 2018, so even if the BoE does raise rates Thursday the odds of Sterling seeing any meaningful gains is slim.
"Even a dovish hike could end up as a GBP negative event, given the current pricing of BoE," writes Andreas Steno Larsen, a currency strategist at Nordea Markets, in a note Wednesday. "If the MPC set aside credibility considerations, there are no reasons to hike in the UK. Core inflation will drop towards 1% over the next quarters on our models."
Changes in interest rates are normally only made in response to movements in inflation but few now see current or future domestic price pressures as sufficient to justify higher interest rates. The BoE's mandate is to keep inflation at 2% and, to the extent that it can, use monetary policy to support the government's economic objectives.
UK inflation held steady at 2.4% in June when economists had been looking for it to rise to 2.6%, and has fallen from 3% back in January. Core inflation, which excludes energy and food items from the goods basket measured, fell from 2.1% to 1.9% in June and is down from 2.7% in January.
BoE officials had forecast in February, when the consumer price index was still at 3%, that it would remain above the 2% target until at least the first quarter of 2021. The adjusted the projections in May to show the consumer price index at exactly 2% at the end of their forecast period.
"The unemployment rate remains glued to the latest non-accelerating-inflation-rate-of-unemployment (NAIRU) assessment of around 4.25%, while wage growth has decelerated compared to latest inflation report from May (from 2.9% to 2.7%)," Larsen notes. "Core inflation has surprised on the downside compared to the May inflation report, while headline has developed more or less in line with the May projections from BoE."
Advocates of a BoE rate rise, often known as "hawks", frequently cite forecasts of rising wages among the general population as grounds for thinking that inflation will rise again later this year, taking it further back in the opposing direction of its target. This justifies an interest rate rise, according to the hawks.
However, wage growth has remained tepid this year too, despite BoE statements in February that suggested it would reach 3% later in 2018. UK wage packets grew by an average of 2.5% during the three months to the end of April, down from a peak of 2.8% back in February and exactly the same rate of growth seen during the three months to the end of December 2017.
"In sum, it is hard to see any reason for increased optimism on wage growth and core inflation in UK compared to the inflation report from May," says Larsen.
The inflation and wage data emerging since May, as well as the BoE's own forecasts, counter much of the argument for an interest rate rise in August. Yet markets are betting heavily that one will be delivered Thursday and the series of Bank of England officials to have delivered speeches during recent weeks have done nothing to deter that view.
Pricing in overnight index swaps markets, which enable investors to protect themselves against changes in rates but also provide insight into expectations for monetary policy, implied a September 13 Bank Rate of 0.70% Thursday.
This suggests a very high probability the BoE will have raised rates to 0.75% before then but it is September 2019 before that implied rate rises anywhere close to the 1% that would prevail if it hiked again after this Thursday.
That leaves Pound Sterling caught between a rock and a hard place. There is little the BoE could credibly say about inflation or wages to justify warning of further rate hikes to come and the market has already taken August's rate rise to the bank despite that it is yet to actually be delivered.
As a result, if the BoE even raises rates at all, the forward guidance Sterling needs in order to sustain a rally is almost certain to be omitted from Thursday's statement, or just too mild to make a difference. This tilts the balance of risks decisively against the Pound this week.
"Ultimately, we think the MPC will vote to keep rates unchanged by a 5-4 margin, but the view hinges on a dovish revision of the projections by the BoE staff. The bottom-line is that we favour a short GBP position in to the meeting from a risk/reward perspective," Larsen concludes.
The Pound was quoted 0.02% lower against the US Dollar at 1.3115 during the noon session Wednesday and is down 2.81% for 2018, while the Pound-to-Euro exchange rate was 0.11% higher at 1.1236 but has fallen 0.15% in 2018.
Elsewhere, strategists with TD Securities see the prospect for a rise in the value of Sterling on the Bank of England event, but warn gains are likely to prove limited.
"Our base case suggests modest, short-term upside risks for GBP but range trading is likely to reassert itself after a large knee-jerk move. Ongoing Brexit concerns remain an offset to any benefit from higher rates," says James Rossiter, a strategist with TD Securities in London.
Under such a scenario the Pound-to-Euro exchange rate is seen heading to 1.13, the Pound-to-Dollar exchange rate is seen edging up to 1.32.
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