UK: Sterling bears don't have much to fear from the Bank of England – Deutsche Bank

Oliver Harvey, Macro strategist at Deutsche Bank, questions that with a further 4% fall in GBP TWI and spectacular rise in break evens since August, how much do sterling bears have to fear from the Bank of England?

Key Quotes

“We think the chances of a material shift in policy are limited.

First, a tighter monetary policy stance based on expectations of easier fiscal policy and structurally higher inflation due to tariffs and shrinking labor force growth would be politically pre-emptive. The market will probably have to wait until the Autumn Statement on the 23rd November for more detail about fiscal stimulus. Despite the hawkish rhetoric from the Party conference, the government’s negotiating position with respect to Brexit has yet to be clarified.

Second, it would be counterproductive. A tightening in monetary conditions would amplify any shock caused by the triggering of Article 50 in March. The experience of 1992 ERM exit suggests that the market may challenge a tighter policy stance based on expected future deterioration in the housing market. Despite the bounce-back in the PMIs, leading indicators of house prices like the RICS survey remain at depressed levels.

Third, valuations are not at extremes. Our models suggest EUR/GBP is at fair value around current levels while historically the cross has tended to trade in a 20% under and overshoot range. On a FEER, or sustainable current account basis, sterling is still close to 10% overvalued. Given the terms of trade deterioration implied by Brexit, the current sell-off is hardly unjustified. This should limit any FX intervention other than to assist price formation.

In sum, we don’t think the MPC will encourage further FX weakness by signaling a cut in November, but this is priced anyway. With GBP/USD closely tracking the UK’s 5y5y real yield, a greater risk is that the Bank downplays the prospect of QE extension in January, but the MPC are likely to be wary of encouraging a steep sell-off in nominal yields near term.”