The BoE’s July meeting was a strange affair for many, as the bank pressed ahead with a further .25% rate increase, lifting rates to 0.75% for the first time in a decade, yet the GBP sold off in reaction. So, what actually happened during the meeting and why did the Pound react this way?
The bank’s unanimous decision to raise rates caught the markets off guard given the dissent we saw last time rates were raised in November, where both John Cunliffe and Dave Ramsden voted to keep policy unchanged. To put it simply, the markets were not expecting them to have a change of heart. Speaking recently, Ramsden said that he feels “more comfortable” with the balance of risks in the economy. Similarly, Cunliffe who, despite calling for “stodginess” in the bank’s approach to rate setting, also voted in favour of a hike. The level of unity in the vote is a sign of a more hawkish shift within the members of the bank and that’s what the market was not expecting.
In terms of the statement accompanying the decision, there was little difference from last time’s statement with the bank noting that its forecasts were “broadly similar” to those made three months ago. The BoE restated its view by stating that if the economy continues to develop as expected, an “ongoing tightening” would be needed to hit the inflation target.
There were, however, two hawkish signals in the forecasts. The BoE has now moved beyond the point at which it projects space capacity gives way to excess demand from early 2020 (as forecast in May’s inflation report) to the end of 2019. Furthermore, the BoE repeated its view that recent data confirms the bank’s earlier judgment that weak growth over the early part of the year was only temporary.
Growth was revised down in both the front end and back end of the forecast horizon, though was revised higher in the middle of the horizon. For inflation, the bank revised its forecasts higher, partly due to the fall in inflation expectations over recent months. However, the constant-rate forecast for inflation at the target horizon was revised lower to 2.2% from 2.37% previously. Typically, it is suggested that each .25% hike takes off around 0.1% of inflation, so this forecast suggests just one interest rate rise per year over the target time frame.
Carney Highlights Brexit Fears
However, the biggest blow to the GBP came during the press conference following the meeting where the BoE Governor highlighted the risk arising from Brexit. Notably, the BoE refrained from giving any signal as to when the next rate hike might occur, which is most likely linked to the high level of uncertainty stemming from ongoing Brexit negotiations. Talk of “no deal” has been rapidly increasing recently and investor concern is growing in parallel.
Commenting on the situation, Carney said “I think the possibility of a no deal is uncomfortably high at this moment. Our responsibility in the other half of the bank – our job is to look at what could go wrong and what we could do to make sure that the Bank is in a robust position so it lessens the impact of a no deal Brexit. “We have made sure that banks have the capital, the liquidity that they need and we have the contingency plans in place… if there were to be a no deal Brexit.. A no deal Brexit is highly undesirable.”
With this in mind, it seems reasonable to expect that the BOE will remain on hold until after Brexit is completed to assess the impact from the leaving scenario, essentially giving bulls nothing to get excited about, hence the sell-off this week.
GBPUSD continues to move within the bearish channel which has framed price action recently following the sharp decline from the 1.4351 level earlier this year. Price is now fast approaching the big 50% retracement level from 2016 lows at 1.2899 which is a major level. Momentum studies suggest the downward move is running out of steam with the RSI highlighting bullish divergence, so there is the chance that we see a reversal from this level.