BoE Finally Upgrades its View

24 hours after sterling plunged on unexpectedly weaker inflation figures, the currency rallies back above $1.60 on the Bank of England’s upgrade of growth, employment—despite a downgrade of its inflation view.

The BoE upgrade of its GDP view was no surprise after the array of strong over the last 3 months as well as the upward revisions from private sector economists and the IMF.

Lowering the inflation forecast closer to the 2.0% level was also no surprise after Tuesday’s release of the 2.2% figure in October CPI.

Bringing forward its forecast for 7% unemployment to Q3 2015 from Q4 2016 may also have been of no great surprise but bears significant implications. 7% is the threshold for which the BoE said would begin positioning for higher interest rates. The central bank indicated that 7% was not a firm boundary below which it would necessarily be forced to raise rates (especially if inflation remained around its preferred 2.0% level).

Nonetheless, the opposite argument could also be made that if employment growth remains on the rise and monthly unemployment figures continued to fall below their 3-month moving average (as they have over the past 12 months) and unemployment drops below 1.2 million, then tapering the £375 bln in monthly purchases would become an item for next year.

While the low inflation figures cement the case for the BoE to remain on hold until 2015, this path will not be devoid of returning speculation of further dovishness if the BoE were to lower its 7% unemployment threshold to say, 6.5%-6.7%. The fact the BoE has upgraded its GDP view and downgraded its inflation view produces the notion of higher growth and low inflation, which should not necessarily be negative for the currency as in the case of lower growth and lower inflation would imply. The low inflation figures may imply less pressure on the BoE to tighten sooner than later, but the upgrade in growth forecasts paves the way for faster decline in the unemployment rate towards the 7.0% threshold.

We see the possibility for a short-term decline near in GBPUSD 1.5800-1.5770s before a gradual recovery back to 1.6100 and 1.6300.