Post-BoE Meeting - March 2017

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Sterling spikes after BoE member Forbes votes for immediate interest rate hike

 

The Bank of England caught investors off guard on Thursday after one of its more senior policymakers, Kristin Forbes, unexpectedly voted in favour of an immediate interest rate increase at the bank’s latest MPC meeting.

Forbes, generally seen as one of the more hawkish members of the rate setting committee, caused the first split vote since July 2016, claiming that domestically generated inflation had increased notably. Moreover, the minutes showed that "some members noted that it would take relatively little further upside news on the prospects for activity or inflation for them to consider that a more immediate reduction in policy support might be warranted”. The BoE is also forecasting relatively strong growth of around 2.0% this year, far from levels that would warrant near zero interest rates.

The communications from the Bank of England were distinctly more hawkish than the market had been anticipating prior to the meeting, with Sterling rallying by 0.75% against the US Dollar to its strongest position in two weeks (Figure 1).

 

Figure 1: GBP/USD & GBP/EUR (16/03/2017)

Figure_1_GBPUSD___GBPEUR__16032017_.png

Source: Thomson Reuters Date: 16/03/2017

 

We have been saying for a number of months now that financial markets are underestimating the chances of an increase in interest rates by the Bank of England this year. The UK economy has continued to weather the uncertainty created following the Brexit vote remarkably well, and significantly better-than-expected in the immediate aftermath of the referendum. So far there has been relatively little feed through to the real economy, even amid the imminent triggering of Article 50 which looks certain to take place before the end of March.

The latest business activity PMI’s have been impressive and comfortably above the level of 50 that denotes expansion. The UK’s composite PMI increased to its highest level in a year-and-a-half in December, helped in part from the effect of a weaker Sterling. Inflation has also increased rather sharply since the Pound slumped following last June’s referendum. Headline consumer price growth rose to a two-and-a-half year high 1.8% in January while core inflation, which strips out volatile energy prices, also increased to 1.6%, just shy of the 2% target.

Markets were pricing in less than a 10% chance of a hike before the end of December 2017 a couple of weeks ago. This has risen to around 28% following today’s announcement (Figure 2), although we think that even this is too low given the sharp increase in inflation and the solid outlook for growth.

 

Figure 2: Market Implied Probability of BoE Hike in 2017 (Jan ‘17 - March ‘17)

Figure_2_Market_Implied_Probability_of_BoE_Hike_in_2017__Jan__17_March__17_.png

Source: Bloomberg Date: 16/03/2017

We think that the prospect of higher rates in the UK towards the end of the year, and the fact that the market is currently pricing in the worst case scenario to the Brexit negotiations, should keep Sterling fairly well supported around current levels against the US Dollar throughout the remainder of 2017. We also forecast a relatively sharp appreciation against the Euro.

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