Sterling Reverses Lower on BOE

<br /> Sterling Reverses Lower on BOE – Marc to Market<br />


The market heard a dovish Bank of England today and sent sterling down by around than one percent.  Initially sterling had reached its highest level since the US election;
extending its recent rally a little through $1.27, but has now reversed lower.
A close below yesterday’s low ($1.2540) would be a potential key reversal. We
had identified several technical signals that had suggested potential toward
$1.28.  Trend line and technical support are
found between $1.2490 and $1.2525.  A break could signal a move
toward $1.2400-$1.2430 initially, and maybe $1.2260, if/when the US dollar
rally resumes. 
It is difficult
to identify the dovish impulse.  
It is possible the many participants had expected a more hawkish
message,  Yet it revised up growth, warned that inflation would likely
overshoot its 2% target on a two -year outlook.  It completed its Gilt purchases
but have a few billion more of corporate bonds to buy to reach its GBP10 bln
target, but is running well ahead of schedule.  
The growth
forecast for this year was lifted substantially: from 1.4% to 2%.  
Growth is expected to slow to 1.6% in 2018
and 1.7% in 2019.  Inflation is expected to be 2.6% in two -year and peak
near 2.8% in  H1 18.   The dovish tint to the growth forecast that
has implications for inflation expectations comes from the BOE discovering
spare capacity in the UK economy. 
The slack is in
the labor market. 
 Unemployment, the Bank of England
now says, can fall to 4.5%.  Previously 5% was thought to be full
employment.   For policymakers, this means that the economy growth may not
be inflationary.  In turn, that
means that the projected increase in inflation may not be so worrisome and more
transitory, having to do with sterling’s past slide and the recovery in oil
prices.  Later this year, large parts of the fall in sterling and the
increase in oil prices will drop out of the comparisons (base effect).
Previously the
Bank of England expected Brexit to take 2.5% off the size of the UK economy.
  Now its says 1.5%.  Carney
defended the earlier and aggressive response to the referendum.  Some
argue that the resilience of the UK economy means that stimulus was not needed.
Carney thinks that the steps the BOE took helped undergird consumer and business confidence and helped buoy the
Carney also
reiterated that the central bank is inclined to tolerate an overshoot of inflation. 
 He also balanced this by repeating the caveat:
 its tolerance is limited.   These comments did not break fresh
ground, and it would seem a stretch to link these with sterling’s sell-off.
 Inflation expectation by the five and 10-year breakevens eased about four
basis points today to 3.26% and 3.41% respectively.  The conventional Gilt
yields fell six-seven basis points.  Liquidity considerations may help
account for the decline in the breakevens, which remain at elevated levels.  The
10-year breakeven has risen 40 bp since the end of last year.  The
five-year breakeven is up 20 bp.  
Another issue
that investors will want to monitor closer going forward is consumer spending. 
The Bank of England noted that it was being fueled by new
borrowings and a draw down in savings. This may
be worrisome because the full extent of the squeeze on real earnings has not been felt.  It may still be as much as a
year away unless wage growth accelerates
or inflation slows.  Neither seems
particularly likely.  Also, with short-term mortgages, there is a
relatively quick pass through of higher market rates.    
In equities,
the FTSE 100 was aided by the drop in sterling. 
 It rose 0.4%.  It is interesting that although
most major markets fell, the FTSE 250 eked out a small gain (~0.1%).  Most
sectors were down, but information technology and materials blunted most of the
Tomorrow the UK
reports the service and composite PMI. 
 Both are likely to have slipped a
little, but after the BOE, the immediate data is unlikely to be market moving. Next week’s highlight includes
December trade figures (slightly smaller deficit is expected) and industrial output (a small decline is likely after
the heady 1.2% gain in November).  Data from the fourth quarter may interest
economists, but it is unlikely to alter
investors’ views.  


Sterling Reverses Lower on BOE
Sterling Reverses Lower on BOE

Reviewed by Marc Chandler

February 02, 2017

Rating: 5

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