GBP: Second guessing the BoE – Rabobank

On the back of the vulnerability of the consumer sector, at the start of last month the UK money market had pushed out expectations for the first BoE rate rise to 2019, points out Jane Foley, Senior FX Strategist at Rabobank.

Key Quotes

“The surprising news that three policy setters had voted for an immediate rate increase in June then forced the market to re-evaluate (McCafferty, Saunders and Forbes are hawks, though Forbes’ term has now expired).  At his Mansion House speech last month, BoE Governor Carney stated that now “is not the time” to raise rates.   After all, cost push inflation is already squeezing consumers’ incomes and a rate rise would compound that impact.  Earlier this week Vlieghe cautioned that rate hike talk was premature suggesting that he too was in the dovish camp along with Cunliffe and Carney.  However, last week Carney did clarify the conditions which could force his hand on rates and this included a scenario when rising investment would counter the negative impact on growth of a stalling consumer sector.  He also assumed stronger wage inflation consistent with the projections of the May Inflation Report, even though earnings growth in the G10 has remained subdued.”

“The fact that wage growth is stubbornly low in countries such as Japan and the US irrespective of strong labour markets suggests that structural factors are keeping pay rises depressed.  Earlier this year the BoE revised lower its forecast for the natural rate of unemployment (the rate which it expects will be associated with labour shortages and wage inflation), due to the persistent slackness in pay rises.  In the UK the latest set of labour data showed a moderate in wage inflation to 2.1% 3m y/y despite a low unemployment rate.”  

“Even though the BoE may be too optimistic on the outlook for earnings growth, its survey is suggesting that investment growth has been rebounding after an initial hit after last June’s Brexit referendum.  That said, the rise in political uncertainty after last month’s election combined with continued Brexit related unknowns and the shrinking time horizon until the UK exits the EU could be negative factors both for investment and the pound.”  

“Insofar as the BoE attributes the current spike in CPI inflation to last’s year drop in the pound, it is reasonable to assume that further sterling weakness would not be welcome by the MPC.  This would risk a further increase cost push inflation, a more erosion of real incomes and softer consumption levels.  As a consequence, we expect that the BoE will produce further hawkish signals in the coming months even though we do not expect a rate rise unless GBP plunges once again.  In recent weeks cable has been supported by a soggy USD and we look for GBP/USD to end the year around 1.28.  We expect GBP to soften vs, the EUR towards the 0.90 area by year end.”