Ahead Of The BoE

Key Developments Post Brexit

  • In the immediate aftermath of the results being announced, Carney took to the wires announcing that the BOE stood ready to provide extra capital to cushion markets. Since then we also had the release of the BOE’s financial stability report which announced the lowering of the counter-cyclical buffer rate applied to banks in an effort to free up to £105bln for lending.
  • We then also heard, in a second televised address, the BOE governor noting that uncertainty was likely to remain elevated for some time and the bank would now continue liquidity auctions for banks on a weekly rather than monthly basis alongside considering a host of other measures. Finally, carny noted that that “the economic outlook has deteriorated and some monetary policy easing will likely be needed over the summer. “as well as saying that in August we will also discuss further the range of instruments at our disposal
  • During this release we also heard Carney noting the decline in Sterling was a normal function of market but warned that sustained capital outflows could lead to a continued and undesirable decline in Sterling.
  • In recent days Carney has come under fire from allegations that he was coached by Government to scare the electorate into voting remain by exaggerating warnings of the economic damage that Britain was likely to incur as a result of Brexit. Carney thoroughly denies this however and stated that the views of the FPC are the views of the FPC and are not pre judged or pre decided.
  • Referring to the reduction in bank buffer rates Carney said that the move is not expected to be a “silver bullet” but that it would help send a message to businesses and households that banks did have money to lend and that there would be no repeat of the 2008 credit crunch and Carney reiterated that the BOE has the tools to ensure both monetary and financial stability and noted also that the weakened Sterling exchange rate could actually positively affect Britain reducing the current account deficit by about a third.

Market Reaction Post Brexit

  • GBP Fell 11% initially against the USD as the results came through, bottomed out at over -13% and has since staged a small recovery back to -11.5%.  The large, initial, shock move was fairly limited in terms of duration with a two-day response providing the majority of the decline, followed by some shallower continuation to the downside in response to talk of a summer rate cut and the lowering of the counter cyclical buffer rates.

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  •  With a small rate cut priced in and the official process for the UK leaving the EU yet to commence, at this stage it’s going to take a rather significant catalyst to provide an extension of this move and as profit taking emerges on GBP shorts there is a lot of debate and discussion about what action the BOE is likely to take this time around.
  • Opinions and forecasts are widely split, ranging from keeping rates on hold and allowing more time to elapse to assess the damage, to cutting rates by a small 25bps with the option to cut again in summer, or an immediate 50bps cut now to act decisively
  • So far from where we were pre-referendum when the BOE was looking to guide markets as to when rates were likely to raise again markets are now left in little mystery as to the timing of a rate move, but are now considering a move in the opposite direction and the only questions that remains concerns the scale of the moves.

Market Expectations Ahead of BoE

  • Despite much pre-emptive rhetoric by the BOE chief and the rate swaps markets pricing a 60% probability of a 25bps cut in July the majority of analysts polled by Reuters ahead of the event suggest that the BOE will actually choose to keep rates on hold this time around, choosing instead to wait for the more detailed August forecast.
  • The first data which will give a glimpse into the UK economic condition post-Brexit will be data from mid-July and waiting until the August meeting allows them to properly assess the situation instead of risking potentially responding in an unnecessary way and causing further FX devaluation.
  • It is a fine line though, If the BOE does decide to keep rates on hold it risks damaging its credibility in the markets and suffering a sharp reaction such as we saw with the Euro in response to the ECB meeting of December 2015 where Draghi over promised and under delivered. This line of thinking suggests that the MPC will look to deliver some level of easing at tomorrow’s meeting, such as a small 25bps reduction accompanied by a clear signal of the scale of action we might expect from the BOE in August with most forecasting rate cuts alongside further QE.
  • The key focus here however is definitely on the future guidance at this stage. A 25bps cut is priced in, so is likely to have little impact and really it’s going to come down to what carney signals about the august meeting. Carney swift response and decisive declaration of easing to come, may have worked to calm markets in the short term, but if he now fails to adequately deliver on those sentiments, he could find himself in a tight spot.
  • In terms of gauging market reaction, the moves in response to Carney’s initial mention of additional stimulus following Brexit saw a sharp move lower in GBP, suggesting that should such stimulus materialise there would likely be plenty of scope for further downside with current positioning data also showing plenty of scope for further downside positions to be added.

  • Retail sentiment however supports the idea that the BOE fails to deliver tomorrow, or at the very least, fails to provide a catalyst for further GBP downside. Current retail skew on myfxbook is over 60% ahead of tomorrow’s meeting.

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Quick Recap

Argument for a rate cut:

  • The case for an imminent rate cut is that it would be consistent with discussions concerning the restarting of QE purchases potentially around the time of the Nov 16 inflation report alongside other measures aimed at boosting the flow of lending to the real economy.
  • Additionally, decisive action at this stage maintains the BoE’s (and Governor Carney’s) credibility and assures markets that the bank is ready to follow up on their words, lending stronger support to guidance on future easing, enforcing the weight of verbal intervention.  There were signs of economic downturn in the UK before the referendum and the Bank needs now to step in and provide support in the wake of this latest economic shock.

Argument against a cut:

  • The case against a July move is simply that the BOE are yet to see survey data, let alone hard data and so would prefer to make a more informed decision in August. Furthermore, some analysts suggest that a cut at this stage will hurt the banks by causing a deeper contraction in their interest margins which are the difference between income derived from lending and borrowing fees.
  • The longevity of Brexit risks also poses a complication at this stage with potential for the situation to materially worsen down the line as, for example, the official exit process commences and Article 50 is triggered. If Carney acts too early on he risks diminishing his capacity to act effectively in response to any more crisis scenarios.

For technical analysis and trade ideas across the GBP complex please see the accompanying video below: