Sterling advances after BoE backtracks

The Bank of England holding its rate policy at half a per cent and opting not to re-start its asset purchase programme is surprising, but has been met with a nuanced market reaction overall.

The multinationals-dominated FTSE 100 index initially reacted negatively by losing some 100 points and trading in the red for a while, before recouping and was last 25 points higher, though about 60 points lower than pre-BoE highs.

As we’ve seen from the very beginnings of Brexit, for the FTSE, it’s all about the relative strength of the dollar, the currency which most companies listed on the benchmark do business in, not the weakness of the pound.

Mid-to-small caps, including those on the more domestically focused FTSE 250 index, are again showing the lag seen since the referendum vote versus bigger groups again, following BoE inaction, though it’s less extreme now.

The biggest British-focused shares—most of which are listed on the FTSE 250—have lifted the index into its best week since it fell 14% over two days following the Brexit vote.

The anticipation of a rate cut had been reflected most pointedly in purer-play British equities over the last few days. The lack of one, which will be a surprise to many market participants, is also weighing on mid-caps more.

By contrast, buyers of sterling, particularly against the U.S. dollar (and against the New Zealand dollar) have applauded the BoE’s inaction most unambiguously.

The pound rose the best part of 2% vs. the greenback immediately after the Bank announced it was holding fire, even though it also noted “most members of the (Monetary Policy) Committee expect monetary policy to be loosened in August”.

In keeping with that view, MPC consensus seems to converge on economic growth and activity later in the year. Members forecast that the economy would “weaken in the near term based on early signs” following the Brexit vote.

The Bank singled out commercial real estate prices, where it saw “sizeable falls” in the near term.

However, investors in that sector are several steps ahead of the Bank. Shares of the largest and strongest British developers—British Land, Land Securities—are trading firmly.

Investors had been shocked just under a fortnight ago by a spate of halted redemptions at property funds estimated to hold £15bn in assets, following outflows. But these shareholders appear to be over it, for now.

The indiscriminate sensitivity we’ve seen across the property sector, which also pulled down housebuilders’ shares earlier this month, had also abated at last look.

Shares of Barratt Development, Berkeley Group Holdings, Taylor Wimpey and others are rising by at least a percentage point each as I write this.

For these, the Bank’s signal that easing is still on the card next month appears to be as good as jam today.

More generally, whilst our expectation that the Bank would cut rates by 25 basis points on Thursday was incorrect, our reading of potentially constraining factors, particularly the elastic reaction by British markets following the Brexit vote, still applies.

Financial markets have essentially reduced the urgency of monetary policy easing, allowing the MPC to assess economic readings that will stream in before its next meeting on 4^th August.

If the bank delays monetary easing on that date for a further month, the committee would be obliged to justify continued inaction with a detailed elaboration of improvements across all metrics that it monitors.

Unfortunately, we would also begin to view the authority of the governor as having been softened under such a scenario. His unequivocal warnings ahead of 23rd June even at times stretched to suggestions that rates would have to be raised under some permutations of Brexit.