Market News & Analysis
Will the BOE bite the bullet on the back of CPI?
Kathleen Brooks September 12, 2017 5:49 AM
The big question post today’s confirmation of the jump in UK inflation data is how will the BOE respond to news that inflation is running higher yet again. The increase in the headline rate for August to 2.9% from 2.6% was the highest level for 4 years. Core prices were also up, rising to 2.7% from 2.4% in July. The chief drivers of inflation last month according to the Office for National Statistics were broad based, with prices for clothing and footwear, furniture and household goods and restaurants and hotels rising at their fastest rates since 2012 or earlier.
Watching Carney: Will he bite the bullet?
While a large percentage of these goods are imported and the price rise can still be attributed to 2016’s sharp decline in sterling, this is evidence that the consumer is coming under increasing pressure. If the BOE won’t step in to ease the pressure on the consumer now, then when will it? While we doubt that a rate rise is on the cards for later this week, we believe that there is a chance that the vote split could signal a hawkish shift at the Bank, with the potential for chief economist Andy Haldane to vote for a rate hike. It is also interesting to see how the Governor votes. Although he has been concerned about growth, in a speech in June he mentioned the fact that the BOE could not ignore rising prices indefinitely. Is now the time for the Governor to put his money where his mouth is and actually vote for a rate hike? If yes, then sterling is likely to fly high, with $1.35 a possibility for GBP/USD.
While we may be too soon in our call for a vote for a rate hike from the Governor of the BOE, if inflation continues in this direction then it won’t be too far away. The Overnight Index Swaps market has already rushed to price in a greater probability of a rate hike from the BOE by year end. The market now expects a 30% chance of a hike in December, this compares with 20% a week ago.
Why the BOE may hike before the ECB
We believe that there is a rising chance that the BOE may act before the ECB on hiking interest rates and normalising monetary policy. Firstly, the currency. The ECB “disappointed” some in the market last week by failing to announce when it will taper its asset purchases partly because of the strength in the euro. In contrast, the pound still remains extremely weak compared to where it was just over a year ago. Secondly, although the Eurozone recovery story is in full swing and some fragile economies are finally embarking on economic growth, there are still some weak spots, for example Italy’s growth may have bounced back but its unemployment rate has started to rise again. This means that the ECB needs to tread carefully to ensure it doesn’t stamp out economic recovery. While the UK economy has been subdued, Brexit uncertainty hasn’t triggered a sharp economic downturn and business investment is still holding up well. This gives the BOE more reason to hike rates sooner than the ECB.
The market impact:
Unsurprisingly, yields and interest rate markets have had the biggest impact, with the 10 year yield rising 6 basis points to 1.08%, the 2-year yield has backed away from its high of 0.24%. However, we still think that the 2-year yield can break back above 0.25% in the coming days and help the GBP recovery story, particularly against the euro.
EUR/GBP has suffered heavy losses in the aftermath of the inflation data and it is now testing its 50-day sma at 0.90, below here 0.8930 – the 38.2% retracement of the April low to late August peak – could act as short-term support. Another level to watch is 0.8950 – the top of the daily Ichimoku cloud. A break below this level would suggest a short term end to the downtrend, or it could act as good support if GBP fails to hold onto its mojo.
GBP/USD reached its highest level in a year earlier, although it has backed away from earlier highs. In fairness, if the pound can’t rally when the dollar is this weak then something would be amiss. At this stage, cable moves are as much about USD weakness rather than UK inflation.
Risk is on as yield rise remains friendly
Elsewhere, risk is on, geopolitical risks are put to bed until the next time the US/ and or North Korea do something unexpected. The bond market is taking centre stage after an impressive 12 point rally in US Treasury yields since Friday. The weakness of the dollar remains a mystery, but it’s a tough trade to fight. The pound is ahead of all other G10 currencies, which is weighing on the FTSE 100, the weakest performer in Europe so far today. Whether or not the pound’s resurgence can last the week could depend on the BOE and the vote split on Thursday. Rising bond yields remain risk-friendly and are failing to dent equity market gains, US futures point to a higher open later. The market is waiting to see if Apple can pull something out of the bag with its launch of the latest iPhone tonight, if it impresses then stock markets would be given another lift.
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