The following article was written by Jasper Lawler, Senior Market Analyst at FCA regulated broker London Capital Group Holdings plc (LON:LCG).
Mistrust a future issue for BOE
Jasper Lawler, LCG
The resignation of Charlotte Hogg for failing to follow her own conflict of interest rules on top of incorrect Brexit forecasts that some argue were influenced by ex-Chancellor George Osborne’s “Project Fear” shows a Bank of England at risk of falling from grace.
A partisan financial community mostly in favour of remaining in the EU still defends the Old Lady but it is a difference story in political circles. Mistrust of the Bank of England’s independence from City financial interests could add to uncertainty at a future date, especially during any economic downturn.
Inflation and unemployment at target
If one were to look at inflation and unemployment data in a vacuum, Bank of England governor Mark Carney should be signalling the intention to raise interest rates. The rebound in the price of oil and a slowdown in food price deflation have caused a rise in UK inflation. This is expected to accelerate in 2017 as the effect of a fall in the pound passes from producer to consumer prices. The jobless rate in the three months through February of 4.7% is the lowest since 1975. Of course there other factors at play and we don’t expect any such signal.
Inflation report hearings in February saw Bank of England Governor Mark Carney reiterate the UK central bank’s neutral outlook for interest rates. We don’t expect this to change at the March meeting in which there is no inflation forecast or press conference. We expect unanimous votes for no change in the Bank rate and the quantity of purchased Gilts (£435bn) as well as the continuation of corporate bond purchases until the stock of purchased corporate bonds reaches £10bn.
We continue to believe the ‘neutral stance’ will last through the first half of 2017. The MPC’s dovish view of the UK economy post-Brexit will mean they are in no rush to raise rates, but there is unlikely to be the economic justification for further easing.
Brexit bill trumps BOE for GBP
We said in December ‘The Bank of England on the side-lines will make the direction of the pound a function of political considerations, including when and the way in which Article 50 is triggered.’ Scope for a second Scottish referendum has rekindled political risks for the pound, again overshadowing the Bank of England. The proximity of the Fed’s first rate hike in 2017 will make the Monetary Policy Committee especially cautious.
GBPUSD is near the bottom of a 1.20-1.27 price range that has been in place since the ‘flash crash’ last October. Given the size, global importance and proven history of ingenuity in the UK economy we would consider fair value for GBPUSD closer to 1.50. UK-US interest rate differentials remain planted to the floor on expectation of tighter US monetary policy. Should the Federal Reserve start to waiver on its pace of rate hikes, GBPUSD could be a major beneficiary. Sterling is significantly undervalued at 1.20 but political uncertainty is keeping institutional buyers away, making a further drop to 1.15 a possibility. Nonetheless our base case scenarios is that GBPUSD recovers 1.30 in the next twelve months.
EURGBP has been a better place for pound strength. European election risk and quantitative easing from the European Central bank has kept the euro relatively weak. Absent a major Brexit-induced shock, a more neutral BOE should lead to the further unwinding of pound shorts against the euro on the reduced scope for expanded QE and a 0% bank rate in the UK, taking EUR/GBP back towards 0.80 over the medium term.
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