The Bank of England owns today, though
tomorrow will be about the US jobs report. The BOE disappointed the market
last month by not immediately responding to the UK referendum. It had
laid out a somber economic and financial scenario as a risk case if the UK
chose to leave the EU. At the time, and even after the referendum, some accused
Carney of being too partisan.
The Bank of England Governor did seem to be exaggerated when he claimed that the UK
economy was slowing in the spring due to holding the referendum in the first
place. We have subsequently seen the preliminary estimate of Q2 GDP
which show that the economy activity had increased a little over Q1.
However, what that risk scenario that the BOE is presented is now more or less the base
case. The forecasts will be updated today, but the sobering surveys
(PMI and CBI) and NISER projections are fairly consistent with what the BOE had
anticipated. There must be some calibration between the forecasts,
even given a confidence interval around them, and the actions the BOE takes or
suggests it can take.
That said, the inflationary pass-through of
sterling’s depreciation (import and consumer prices) is unlikely to deter
significant action. The impact from sterling is temporary
and price pressures are beginning (when the Brexit shock hit) was just above
zero.
In terms of
policy, there are three elements. First is the base rate itself.
It stands at 50 bp. The failure to cut it would be a major
disappointment to the market at this juncture. Most look for a 25 bp cut.
In the past, Carney (though perhaps it is also an institutional judgment)
has shown a reluctance to cut rates too close to zero, let alone negative
interest rates. There are some calls for a larger than 25 bp cut; we suspect the BOE is not persuaded that the additional marginal rate cut will have much impact.
Second is asset purchases. The
market is nearly split on whether the BOE
announces a new asset purchase program (QE). Those that do expect
QE are mostly anticipating a GBP50-GBP75 bln program over several months.. There has been some
talk that the BOE could buy corporate bonds. Here too we think the odds
do not favor innovation when it is not necessary.
Third is a funding-for-lending scheme (FLS).
This facility provides long-term funding to banks and building
societies. The amount and rate is linked
to their actual lending. The program has been in existence since 2012 and
has repeatedly been renewed, most
recently late last year. Currently,
borrowing is allowed until January 2018. This program may be broadened. If it is not, it would not
be a significant disappointment.
Given that some easing by the BOE has been
well telegraphed, in order to get the
most impact from today’s decision may require that market participants are given the impression that the BOE is
prepared to do more; that it has not exhausted monetary policy.
That might translate into holding
back. Perhaps it could be intimating it can renew asset purchases,
but stopping short of launching a program now.
Arguably, and this is what the shadow MPC at
The Times argued, the economic fallout from the referendum is not something
that monetary policy can address when interest rates are already low.
This might be a job better performed by
fiscal policy. It may be more a question of political will
than technocrat turning of a dial or
pulling a switch.
We suspect there is a greater risk that the
market is disappointed or that there is a sell the rumor buy the fact type of
activity that the BOE surprises the
market with its aggressiveness. Sterling rose to around $1.3370 yesterday, and this could be retested today. A move above there
will target the $1.35 area which is technically significant. A trendline
drawn off the lows comes in near $1.3160 today. Also, we
note, that the bookmakers in London have tightened the odds that Article 50 is
not triggered until 2018 or later.
There are a few other developments to note
today outside of the Bank of England. Regarding
economic data, the highlight has been Australian retail sales. June
sales rose 0.1%, half of the may increase and a third of what was expected. In real terms, retail sales
rose 0.4% in Q2 after a 0.5% increase in Q1. It is the weakest quarterly
advance since Q2 14. The market looked past it, and the Australian dollar
is the strongest of the major currencies today, rising a little more than a
third of a percent. Despite the rate cut earlier this week, and the lower
trend in commodity prices, the Australian dollar has proven quite
resilient. It has advanced nearly 1.5% over the past five sessions,
making it the strongest currency after the Japanese yen (3.8%).
Japan’s Ministry of Finance reported that last
week foreign investors bought JPY1.091 trillion of Japanese bonds. This is the second highest weekly figure this
year. The buying spree was also surpassed once in 2015. These late
longs hit a rough path as yields have backed up sharply this week. The
generic 10-year bond yield, for example,
has finished last week at minus 19 bp. Today it closed near minus
eight bp. The BOJ’s Iwata today
seemed to play down the likelihood of a new move next month by saying that
there is no specific policy direction in mind.
Oil prices staged an upside reversal yesterday
as participants put more weight on the sharp decline (nearly 10x larger than
expected) of gasoline inventories than the build of crude stocks.
There was initially follow through gain, but they were marginal, and oil prices
are slightly lower on the day presently.
After the flurry of UK activity, the market
may briefly turn its attention to the US data. Today’s calendar
features weekly initial jobless claims, which are little significance ahead of
tomorrow’s national jobs report. June factory and durable goods
orders. These are June reports. They could impact projections for
revisions to Q2 GDP (recall that weakness in construction spending reported earlier
this week gives an initial lower bias for revisions).
The euro has seen some follow through selling
after yesterday’s losses in North America. While support near $1.1100
may be frayed, only a break of the $1.1065 would be technically significant. A move now above $1.1160 would
stabilize the tone. Like yesterday, the dollar continues to trade
within Tuesday’s range against the yen.