July BOE Recap
Investor expectations ahead of the meeting were largely tipped in favour of easing with the rate swap market pricing a higher than 60% probability of a cut. Industry analysts were also aligned around a 25bps point. However the BOE refrained from easing at the July meeting despite one member voting in favour of a cut
The BOE judged that they needed to see more post Brexit data before making a decision and declared their intention to conduct a detailed and thorough analysis of all available policy options at the August meeting concluding that “Most members of the committee expect monetary policy to be loosened in August”.
Data & Developments
Incoming UK data since the last meeting has been a mixed bag with a clear divide between positive pre-Brexit data and a stark downturn in post-Brexit data.
- June CPI 0.5% vs 0.4% headline and 1.4% vs 1.3% core
- 2q GDP YoY 2.2% vs 2.1% and QoQ 0.%6 vs 0.5%
- Jul gfk consumer confidence -12
- Unemployment rate 4.9% vs 5% 3/m May, Earnings 2.3% vs 2.3% 3/m May
- Retail Sales June 3.%9 vs 4.8%
- July Services, Manufacturing & Construction PMIs all sub 50
The key takeaways from the data are the terrible PMI prints which, with each printing sub 50, marked the fastest economic contraction since 2009 and Services PMI particularly , a leading UK indicator falling to an 88 month low. Alongside this, consumer confidence in July hit a 7 year low, sharply highlighting concerns for the UK economy in the wake of Brexit.
Positive data prints from June CPI and 2Q GDP lose relevance as they reference the pre-Brexit period and so for now, Though no hard data has been released yet, initial survey data will weigh heavily on the BOE. Indeed, martin Weale, traditionally a hawk, who even recently argued that a rate cut was not needed has in recent days now changed his stance in support of easing.
Market Expectations Ahead Of The Meeting
With the BOE having clearly signalling the strong likelihood of August easing, markets have been piling into GBP shorts with CFTC positioning now showing GBP shorts at all time highs. This data presents a clear risk for the BOE who might struggle to satisfy such an expectant market.
To add to this we also have a high level of retail market short positioning with shorts currently sitting near 70%
Looking at the reaction that other currencies have had to rate cuts this year further clouds the outlook
- BOJ move into negative rates in January saw JPY sold off on the day but then rally for the rest of the year
- RBNZ March rate cut has seen NZDUSD move 600 pips higher
- RBA May rate cut, saw initial downside but was quickly reversed
- RBA August rate cut saw some initial weakness overnight but then losses were totally reversed over the next day
The precise driver behind these reactions is unclear though it appears to be a combination of the high level of market expectation and the fact that these move are so well priced in ahead of time and also the deteriorating level of effect that these conventional policy moves have in the post GFC world where banks have been slashing rates for nearly a decade now.
Measures Expected Tomorrow
Referring to comments made by BOE Governor Carney who noted that the BOE is still in “the conventional monetary policy” space indicates that the BOE is likely to first employ a rate cut. Indeed, the majority of analysts surveyed by Bloomberg are aligned around a reduction in the headline interest rate by 25bps.
The BOE has clearly communicated in recent months that it has no intention of moving into negative rates and Carney has oft times warned against the dangers of such a move.
With the BOE having held off from cutting rates at its July meeting and there seemingly being some anxiety about cutting rates too low, with concerns aired by Carney, chief economist Haldane and also the more hawkish Forbes, it seems that a 25bps cut alongside some other policy adjustments is the likely route.
Views From The MPC:
Forbes specifically noted that ‘Unfortunately, easing monetary policy not only has benefits, but also costs. People will earn less on their hard-earned savings – potentially cutting back on spending to reach a target savings pot. Banks will make less money – potentially making it harder for consumers and businesses to get loans. Pension and life insurance funds will have a harder time meeting their commitments. Companies may need to put more money into pension schemes, leaving less to spend on workers and investment. There is also the traditional concern from looser monetary policy – inflation.’
Carney himself also noted that ‘As we have seen elsewhere, if interest rates are too low (or negative), the hit to bank profitability could perversely reduce credit availability or even increase its overall price.’
The MPC have however referred to a “package” of policy options which suggests the likelihood of further measures being rolled out along with a rate cut but will these measure include QE?
Unlike 2008 banks have much stronger capital levels and without any serious financial sector solvency and liquidity strains, and with gilt yields at historic lows, there seems to e no urgent driver for further QE gilt purchases which may instead see the BOE turn to its Funding For Lending scheme with the option of restarting QE further down the road, potentially at the next “Super Thursday” in August.
Gauging Market Reaction
Gauging market reaction is a little tricky because as we discussed earlier, the transmission between monetary policy and currency movement has been quite dislocated this year suggesting that rate cuts and currency weakness are not necessarily married to one another.
However, in terms of seeking to identify potential scenarios and opportunities It appears that given the extreme level of positioning, market expectation, and what is priced in, that:
- If the BOE cuts rates by 25bs tomorrow with no further easing, then GBP is likely to rally on disappointment
- If BOE cuts beyond 25bps then we go lower
- If BOE cuts at any level and accompanies the cut with an expansion of QE then we go lower also.
However again referring back to the level of positioning. It feels as though GBP is going to struggle to go meaningfully lower and whilst a surprise tomorrow might see some short term GBP weakness the risk still seems skewed to the topside and before long, we could see a sizeable rally manifest.