Sterling back near July low as r star fades

Summary

The possibility that Bank of England policymakers could embark on faster than expected tightening after inching Bank Rate off its crisis low, now looks dead.

Walking

The biggest surprise for the market was sudden unanimity to lift the rate by 25 basis points.  In the context of the accompanying commentary, which lacks any discernible rise in urgency, unanimity was probably a straightforward sell. The phrase you will remember—because it was well-crafted, and possibly not spontaneous—is that “Policy needs to walk – not run – to stand still”. It capped Governor Mark Carney’s explanation of a new addition to guidance, the ‘equilibrium’ rate. It’s fair to say anticipation of its arrival was more interesting than the introduction itself.

r* shines little light

“There is a wide degree of uncertainty around the estimated level of r*” the BOE explained. It was a good faith effort to improve clarity but, perhaps inevitably, it falls flat by introducing new opacity. Several different possible ‘r*’s were offered, including external sources. The model itself turns out to be a multipart one including an upper-case ‘R*’ - ‘Trend real rate’, a lower-case ‘r*’ – Equilibrium real rate, and an ‘s*’ – Shorter-term component. Each economic input to the model also has estimated equilibrium rates. At some point, the exercise will prove to be a useful addition to the Bank’s guidance tool box. For now, it looks almost irrelevant for that purpose. That view was partly backed by Carney himself setting out a tough set of barriers for improvement in the “equilibrium interest rate to 2%-3%”. These included higher productivity, reduced fiscal headwinds, and less “uncertainty”. The exercise in approximation acknowledges widely assumed realities, even if real ‘r*’ remains a mystery.

Standstill

Inflation and economic forecast updates were also not action-packed, though at least largely static. Inflation in two years’ time would be 2.09%, the report said, implying tightening near that horizon. But expected 1.4% economic growth is unchanged from policymakers’ May forecast, whilst 2019 GDP ticks just a tenth of a percentage point higher to 1.8%. They also acknowledged the sluggish pace of wage improvement as a potential source of upward pressure on inflation by trimming forecast growth to 2.5% for this year. They then see a rise back to 3.25% in 2019. Policymakers turn out to be on, or near, the same page as the market economically.

Sterling’s round trip

Sterling traded against the dollar acknowledged our read of events with a sharp 112-pip sell-off from an $1.3125 intraday peak. Profit taking reduced the intensity of the offer, but that had also faded at last check. The rate is about 20 price points from Thursday’s low. This action does not seal sterling’s fate for the foreseeable future. After a year of relentless pressure, the easiest thing to predict is heightened volatility, of which Thursday offered another taste. One hourly range just missed being the fifth-largest of the year. Would-be buyers now face another set of U.S. economic data on Friday, in the shape of non-farm payrolls. Precursors—ADP’s take on monthly payrolls, ISM’s manufacturing employment PMI—beat forecasts. Sterling, like the Bank of England’s rate policy is where the market left it before the rate rise. And it too will struggle to stand still.