Forex Trading Library

UK interest rates – A non event at least till May 2015

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The UK’s Bank of England meets today in its first monetary policy meeting for the year. However, the markets by and large are expected to remain muted to today’s policy outcome as well as future monetary policy meeting. It is a widely known fact that the UK has been hit by a slowdown in growth and going by latest releases, we could possibly see growth stall in the fourth quarter of 2014 if not slow down even more.

The dovish view on interest rates is also further fuelled by the fact that inflation has been a drag and with continuing decline in Oil prices, it seems evident that it will take a quarter at the very least for inflation to stabilize to the new norm.

Politically, the Central Bank is also likely to be reluctant to raise interest rates at least until May 2015 when the UK heads to polls. Current political scenario in the country points to a possible coalition government being formed, which is something that the markets clearly don’t appreciate to.

Taking into account all the above factors, slowing growth, slow inflation and the general elections, the BoE could remain muted at least until the second quarter of 2015 before we can expect to see some activity pick up.

However, a major factor to bear in mind would be the MPC votes, which currently stands with 2 dissenters in favor of interest rate hikes. While today’s outcome could likely point to the status quo being maintained, it will be worthwhile to watch the MPC votes as we get closer to the election month, which could give the markets a glimpse into the BoE’s monetary policy committee member’s views in regards to interest rate hikes.

The British Pound started the year on a weaker note supported by weaker PMI’s across the board. Despite the slowdown, the only silver lining is likely to be the labor market which, if the current trend continues could see an improvement in the unemployment rate.

Expect BoE to be more cautious

The BoE miscalculated its forecasts twice in a row. The first being when Mark Carney, BoE governor giving forward guidance expected the unemployment rate to decline as a more gradual pace and had initially tied interest rate hikes to an improved unemployment rate, a la the Federal Reserve’s past forward guidance. Reality however showed that the labor market picked up activity quite rapidly and at one point looked hawkish. However, the unemployment rate has since then stabilized near 5.9% – 6%.

On the second front, the BoE also warned that interest rate hikes would precede real wage growth, which again caught the central bank on the wrong foot. The UK’s average wage growth has been consistently climbing.

And finally, the BoE also got its inflation expectations wrong, although attributed to the unforeseen decline in international crude oil prices.

Considering the above factors, we can expect the BoE to be more cautious in its approach and thus would prefer a more ‘wait and watch’ approach rather than lead the markets with forward guidance yet again. With the ECB’s QE policy decision looming large, it should however provide the BoE with some breathing space, while the markets await the outcome of the general elections. The British Pound, especially against the US Dollar could very well weaken in the months ahead as the election campaign starts to heat up. In this context, today and possibly future BoE policy decisions will continue to maintain rates at 0.5%.

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