This Thursday, we get the BoE’s February rate decision along with minutes from the meeting and the QIR.
Rate hikes are not coming soon. Unemployment keeps falling, but wage growth is not strong enough yet. Downside economic risks are elevated. The forthcoming EU referendum provides uncertainty. The news since November points to low inflation lasting for longer, but not forever. But there are many hurdles before we reach that medium term, making it easy to dismiss for now.
We expect a dovish BoE to revise down growth and near term inflation forecasts whilst keeping the 3y forecast above target.
We consequently expect Thursday’s Quarterly Inflation Report (QIR) to be more dovish than November’s. We believe the BoE will signal the market’s dovish outlook for rates is out of sync with the BoE’s own by forecasting inflation above target at the 3y horizon. However, the market took little notice of this back when November’s QIR was released and with a Brexit vote on the horizon we see little reason for a different reaction this time around.
FX: GBP relief likely to be temporary.
Further GBP weakness likely remains the path of least resistance in the run-up to the Brexit Referendum. However, in our weekly proprietary flows publication, the Hedge Fund community has been taking profit on its short GBP position which hints at some stabilization in the near term. We think such relief is likely to prove fleeting.
Furthermore, given the declining correlation between Fed and UK rate hike expectations, markets may be unwilling to meaningfully bring forward expectations for UK rate hikes until the uncertainty of the EU referendum has lifted. This view seems to have been vindicated in a recent speech, where Carney, when asked on the Brexit debate commented: "I would say at this stage we pick up awareness of political events". Furthermore, and despite his insistence that growth was solid and consumer confidence was high, the question on when to hike rates is "unknowable". We believe UK rates markets will therefore have little appetite to bring forward UK rate hike expectations and GBP will thus lack a significant pillar of support.
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