Morning Briefing – Eyes on BoE (and Downing St.)

<p>The spotlight will remain firmly on the United Kingdom on Thursday after Wednesday evening’s sparkling line-up of political stars brought surprise and intrigue in equal […]</p>

The spotlight will remain firmly on the United Kingdom on Thursday after Wednesday evening’s sparkling line-up of political stars brought surprise and intrigue in equal measure, though with little discernible market impact, so far.

Still, it’s likely the equally speedy formation of Theresa May’s new government after her expedited installation as British Prime Minister has helped the general sense that political stability is returning. And markets certainly like that.

Here’s how the major global markets stood around just before this article went online.

Name Last Pct. Chng. Net Chng. Close
S&P FUTURES  2161.5 0.72 15.5 2146
DJ INDU AVERAGE 18372.12 0.13 24.45 18347.67
BRENT CRUDE Futures 46.81 1.19 0.55 46.26
AUD/USD 0.7642 0.49 0.0037 0.7605
USD/CAD 1.2929 -0.36 -0.0047 1.2976
USD/CHF 0.9805 -0.44 -0.0043 0.9848
EUR/CHF 1.0887 -0.35 -0.0038 1.0925
EUR/JPY 117.2 1.17 1.35 115.85
DAX 10071.09 1.41 140.38 9930.71
NIKKEI 225 16385.89 0.95 154.46 16231.43
S&P 500 2152.43 0.01 0.29 2152.14
FTSE 100 6723.42 0.79 53.02 6670.4
USD/JPY 105.59 1.06 1.11 104.48
GBP/USD 1.3242 0.74 0.0097 1.3145
EUR/GBP 0.838 -0.64 -0.0054 0.8434
10Y BUND     105.978 -0.21 -0.227 106.205
EUR/USD 1.1101 0.12 0.0013 1.1088
SPOT GOLD 1329.26 -0.98 -13.19 1342.45


In short, risk is on, even if just moderately and safe-have assets are being let go for the moment.

Obviously all (other) eyes are on London and The Bank of England and the broad expectation now is that the Bank will oblige by cutting its main rate by 25 basis points. Peculiarly, this consensus—shown in polls of economists by both Bloomberg and Reuters, is the reverse of what appeared to be the widespread market expectation earlier in the week. Reuters was still quoting consensus forecasts that the bank would hold off as late as Tuesday.

Balancing political considerations (i.e. criticism, from Leave supporters and the press) before the referendum and after with recent signals from BoE governor Carney, that further easing of various sorts is imperative, with the reality that British stock markets have not fallen off a cliff, we think the Bank will announce a 0.25% Bank rate cut at 12.00pm London time, but nothing else for now.

The preeminent market for BoE interest rate speculation is ‘short-sterling’ futures, more formally known as 3-month Libor futures, have been pricing in an interest rate cut of at least 25 basis points ever since the referendum vote was known. At last check, the change in base rates over the next three months implied by LIFFE’s 3-month Libor contract was 44.5 basis points, to be precise. That suggests an implausible scenario of one standard 25 point cut and a 19½ slice too. That’s unlikely.

Subsequently—if speculators are a reliable indication—it looks like a quarter of a percentage point cut is on the cards. Markets also seem to be signalling that they expect the Bank to also tinker further around the so-called monetary margins, with a resumption of the asset purchasing programme, running at £25bn, per quarter being the most obvious way to do that. However, we do not think there is any reliable way to predict when QE might restart.

We would expect the risk-on feel over global markets to get fresh legs from a 0.25% rate cut. Whilst in many quarters markets have more than fully priced such a move in advance, we expect momentum effects and imprecisely increased sentiment to propel sterling and UK shares further.

We particularly expect the more UK-rooted FTSE 250 and other indices for listed SMEs to reload and strongly surpass gains of between 2%-4% this week.

A knee-jerk reaction by sterling against the dollar from a 25bp cut, after the pound advanced more than 4% from fresh 30-plus year lows marked last week, should be negative. However we think sterling has fully priced contained easing of the type we expect, and we would see the resumption of the pound’s recovery continuing in short order.

Should the Bank of England surprise with no action or perhaps merely with a resumption of its purchasing programme without a rate cut, we would expect ‘risk assets’ like stocks, particularly those outside of the largely dollar-denominated FTSE 100, to slide.

Sterling’s recovery would accelerate; $1.33 might not be achieved on Thursday, but it would be within easy reach by the European close.

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