cross markets data reaction

Bank of England Decision Leaves Risks to the Downside for British Pound

Tuesday, 06 February 2007 23:35:41 GMT  |  David Rodriguez and John Kicklighter, Currency Analysts

Bank ofEngland Interest Rate Decision (Thursday, 12:00 GMT; 07:00 EDT)

Consensus:                          5 .25%

Previous:                                5 .25%

How Will The Markets React?

Markets are unsure of what to expect for Thursday’s Bank of England interest rate decision, leaving considerable event risk for the domestic currency. This confusion is clearly visible through the past several weeks of price action, with the GBPUSD posting volatile moves on shifting sentiment and trading within a 400+ point range. Predictions clearly favor unchanged rates through the week’s end, with a Bloomberg News poll showing that 42 of 50 respondents expect no hike. Recent news supports such a hypothesis, with a January’s rate hike coming on the heels of a hotly contested Monetary Policy Committee vote. Bank officials approved an interest rate increase by a narrow 5-4 margin; four “no” votes represent the most closely challenged decision since 2005. Futures traders instantly bought interest rate forwards, leaving the March UK LIBOR rate lower through the day. More recently, however, strongly bullish domestic economic data has pushed forward rate agreements higher—leaving the March Euro Sterling contract to price in a 100% chance of a hike through the coming two meetings. The British Pound has seen considerable strength on the shift, but such an uptrend may be short-lived through coming trade.

Bonds – UK 10-Year Gilt Yields

UK bond yields continue to reflect expectations of higher rates through the medium term, with the 10-year Gilt offering a near 5-percent return through today’s close. Such predictions lost traction following the release of minutes from the most recent Monetary Policy Committee meeting, but subsequently positive data has forced 10-year debt yields to retest the psychologically significant 5.00 percent mark. Short-term implications on price action for longer dated bonds tell us relatively little, but the March UK LIBOR rate future shows clear expectations of a 25 basis point rate hike in one of the two upcoming meetings. Given clear hesitation in the vote for the recent rate increase, risks arguably remain to the downside for predictions of higher rates through February and March. This translates into likewise bearish risks for the British Pound, leaving recent strength in jeopardy of retracement. 

 

FX – GBP/USD

In the hours leading up to the Bank of England’s rate decision, FX traders have bid the British pound across the board. However, some of this strength is coming on the part of recent indicators. Nevertheless, the central bank’s upcoming decision has handily guided the currency since the beginning of the week. Equipped with convincing data from the economic coffers since the previous release and the knowledge that the MPC has a penchant for surprises, speculation over a possible rate hike is finding more than a little support. Central to the fundamental support for a rate hike to match the 25-basis point boost in January is the pressure underlying consumer spending and price gauges. Brits increased retail spending in December by 1.1 percent following yet another drop in jobless claims and subsequent jump in average income. More tangible for a monetary policy decision though is the recent inflation numbers. The consumer basket reported 3.0 percent annual price growth, while the retail price index accelerated to a staggering 4.4 percent rate of inflation.

However, all of this data has been handicapped. For one, the most recent interest rate hike has not been captured by most of the recent economic data. Without some clue as to how a 5.25 percent benchmark interest rate is affecting the economy and inflation, there is still some breathing room for the central room to defer another firming. What’s more, the vote at the January meeting casts doubt on similar decision for the future. At 5-4, the boost came on the slimmest of possible margins. Looking to the market for its biased opinion, speculation highly favors a pass. Another interesting situation to keep track of is the ECB’s decision scheduled for the same day. The divergence in policy’s in favor of a hawkish BoE last month has made waves in throughout the currency market. Should conditions be exacerbated, or otherwise rebound, the pound react in kind.

 

Equities – FTSE 100 Index

Overnight lending rates seem to be the furthest thing from equity traders’ minds. Even though the BoE releases it official decision a day and a half from the time of this writing, the benchmark FTSE 100 stock index has steamed ahead. In the past four active sessions, the index has put up green bars; and has subsequently marked a new high Tuesday’s close. However, should another quarter point be tacked onto the nation’s short-term lending rate, the pressure would definitely begin to build. The benchmark indices have survived so far on a combination of impressive export demand and burgeoning M&A activity. Should yet another surprise hike print, the resulting rally in the British pound, and additional burden to borrowers would quickly diminish prospects for the future. On the other hand, the recent strength may be an impromptu statement by the investing community that they see little chance of a February rate hike. While conditions do support such a pass, stocks will likely consolidate in the hours preceding the meeting’s conclusion – just in case.

Resources

• free demo account
• forex courses
• open an account
• forex stream
• free webinars