Since last Thursday, three BoE voters have shown their dovish leanings. Firstly, Governor Carney noted how the rebound projected in the bank’s forecasts for this year was not assured and the “MPC are debating the merits of near-term stimulus”. He went on to describe what such stimulus could look like, detailing an easing package of both QE and rate cuts that would equate to 250bps worth of easing in the pre-financial crisis era. Since then, Tenreyro and Vlieghe have also come out in favour of lower rates, should the economy not rebound as assumed in the bank’s economic projections. Combine these three with Saunders and Haskell, who already voted for lower rates at the most recent BoE meeting, and this could mark a decisive shift at the bank; from dovish minority to dovish majority.
So, now we know the BoE is finally turning dovish, the question for the market becomes when will the first cut come. Money markets currently price a 50/50 chance of a rate cut this month, and a cut with certainty by September. We don’t think the BoE will cut this month, rather we think it will adopt a dovish stance along the lines of “if the data does not improve in the near future, we will cut rates”. Here’s why.
1) Vlieghe and Tenreyro not dovish enough… yet: Vlieghe and Tenreyro have premised their support for lower rates on a failure of UK data to improve, essentially meaning they will need to see more bad data to be sold on a cut. Will today’s horrible GDP and manufacturing production reading’s, which have come since their comments, do the trick? Possibly, but we think not, because the data is from November, when pre-general election uncertainty was at its highest. We think they will want to see a continuation of bad into December, when business sentiment was (supposedly) lifted by the Conservative Party’s emphatic win. Supposedly, the UK economy is meant to rebound now, according to the BoE at least. We think Vlieghe and Tenreyro will want to wait to see December (and even January) data before making the final verdict on whether or not the data is good enough.
2) Over reaction to the Carney comments: When Carney spoke last Thursday, he gave an overview of potential policy routes facing the BoE under different circumstances, including a worst case scenario which would require a significant easing package (as noted above). He also noted that there was debate in the MPC over the merits of near-term stimulus to reinforce the anticipated recovery in the UK economy. The market reacted as if he had implied that he was overtly taking the dovish side of this debate, and was supportive of the significant easing package he had outlined in his worst case scenario, when really neither was definitively implied. At the time, he appeared to be more neutral on both issues. Either way, by noting that the MPC was engaging in a dovish debate implies that the bank must have shifted to a more dovish stance on the whole. Whether or not that mean’s Carney himself is ready for a rate cut is another question. We think he will err on the side of caution/patience, and give the UK economy’s projected rebound a chance to run. Much like with Vlieghe and Tenreyro, should this fail to materialise, we then expect the Governor to support a cut.
One thing is for certain; UK data will take on increased importance in the coming months, as we get to see whether or not the UK economy has been able to rebound in the aftermath of the 2019 general election. Prior to this month’s BoE meeting (30th January) we will know December inflation, retail sales and jobs data. Based on what we know at the moment about BoE voter policy stance, we do not think weakness in any of these metrics will be enough to tip the BoE into supporting a rate cut, rather weakness would solidify the bank’s dovish stance at the upcoming meeting that if the data did not improve a cut would be coming soon. Should further BoE policy makers come out more along the lines of Saunder and Haskell (i.e. we want a cut now), then we would revise this forecast.
What does this all mean for GBP?
In the near term, I think there is a risk of the market getting too excited about a rate cut later this month. That means, despite the BoE overtly adopting a dovish stance and outline the conditions they would need to see for a cut (i.e. a lack of economic recovery), there is a risk the market could be disappointed by the bank’s lack of action (which would be GBP positive). A possible scenario I envisage playing out is that UK data between now and the meeting could come out worse than expected, fuelling hopes for a cut, only for the market to be disappointed when the BoE holds rates. Either way, expect GBP to be highly sensitive to data between now and this month’s meeting.
In the long term, I am GBP bear. Unfortunately, I think the BoE’s hope for a rebound in the UK economy is wishful thinking. Sure, things are unlikely to be as bad as that November GDP reading, but no deal Brexit at the end of the transition period in December 2020 will continue to cap investment. With the BoE’s rebound failing to materialise, they will have to adopt easier policy (GBP negative), which we think will occur well before the start of H2 2020. Thereafter, we expect GBP pricing to refocus back towards the state of UK/EU trade negotiations. Should things be looking good, GBP could end up back in the 1.30s again. Conversely, should things be going badly, we could see GBP back below 1.20 as a no deal exit screams closer.