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Bank of England Warns of Brexit Risks

Bank of England Warns of Brexit Risks

James Stanley, Strategist

Talking Points:

- The Bank of England elected to hold rates flat at .5% this morning, keeping rates at an ‘emergency low’ for the 83rd consecutive month.

- The BoE surprised this morning in the fact that they made pointed statements towards the upcoming ‘Brexit,’ vote, saying that a vote to leave would entail higher unemployment, higher inflation, lower growth and a ‘sharp’ decline in the value of GBP.

- If you’re looking for trading ideas, check out our Trading Guides. And if you want something more short-term in nature, check out our SSI indicator.

This morning’s rate decision out of the Bank of England was pretty much a foregone conclusion before it even started, as there were no expectations for an actual move at today’s rate decision. The far more interesting implication that traders were looking for was how the bank might adjust inflation projections given the uncertain outlook for the economy with a vote to leave the European Union a short seven weeks away.

These inflation projections are key for rate policy because this shows what the Monetary Policy Committee might be looking at for future rate hikes; somewhat of a loose guide of longer-term expectations given current conditions. And in most cases, Central Banks try to avoid political issues such as what is currently being debated in the UK, as any potential biases run the risk of distorting policy-maker’s decisions. So many were expecting the BoE to provide some type of conditional outlay for inflation and growth projections whether voters decide to leave or whether they decide to stay.

That did not happen this morning. Instead, Governor Mark Carney came right out and warned of the risks of a Brexit; saying that choosing to leave the European Union would bring lower growth, higher unemployment, and higher inflation. He also mentioned that a vote to leave could lead to sharp declines in the value of GBP. Carney mentioned that the MPC would be faced with the unenviable situation of having to choose whether to mold rate policy to support growth or to dampen inflation; and this is for an economy that just elected to keep rates at an ‘emergency’ level of .5% for the 83rd consecutive month.

The Bank also mentioned that their opinion is that approximately half of the 9% depreciation since November in Sterling prices is due to Brexit uncertainty. The MPC discounted this drop in their analysis, assuming that the vote will stay with the status quo to ‘Bremain’ rather than ‘Brexit.’ So, the Bank of England is assuming a higher rate in the Sterling than what is actually trading today when calculating today’s inflation projections, which were only slightly changed from the last batch of Quarterly projections that we received in February. The bank lowered growth projections for 2016 to 2% from a prior expectation of 2.2%, while also nudging lower projections for 2017 and 2018 to 2.3% from prior expectations of 2.4 and 2.5% respectively.

Most early polls of the Brexit decision aren’t so clear cut, and price action in the Sterling of late has been rather chaotic with multiple forces at work. Mr. Carney had mentioned many of these forces two quarters ago when reducing growth and inflation forecasts, creating a strong move lower in the Sterling (which is actually what began that -9% decline mentioned earlier). On the chart below, we take a ‘big picture’ look at the Cable to incorporate that slide in November as the bank began to take on a more dovish tone after Chinese weakness became a more obvious threat. After bottoming out on February 29th, GBP/USD has begun to put in a bullish structure, a beneficiary of a weaker US Dollar over that period, to be sure. Notice the recently created higher-high and higher-low with near-term price action catching Fibonacci support. This Fibonacci retracement can be drawn by connecting the Financial Collapse low in GBP/USD to the 2014 high in the pair; and 76.4% of that move is the level of 1.4371.

For traders looking to sell USD, this could be an attractive candidate to do so given recent technical structure.

GBP/USD

Bank of England Warns of Brexit Risks

Created with Marketscope/Trading Station II; prepared by James Stanley

We issued a more full-scale technical report on GBP/JPY and the same levels apply today. And this pair is showing the same potential for a recent ‘higher-low’ to have been set, with the differentiation from the above setup in the fact that a new higher-high has not yet been set. This likely has more to do with recent volatility in the Japanese Yen that’s seen rampant strength in the currency ever since the surprise movement to negative rates in January; and a strong pullback over the past week after the Japanese Finance Minister floated the idea of intervention should ‘one sided moves’ in the currency persist.

The big level with near-term price action in GBP/JPY is 156.35, which is the 50% Fibonacci retracement of the 2011 low to the 2015 high. This level came in as support again this morning just ahead of the Super Thursday batch of announcements, with price action now setting a new short-term high in the pair.

For traders looking to get long GBP/JPY, they’d likely want to wait for a cleaner setup as we’ve moved off of support by quite a bit, and it may be difficult to justify the risk outlay given up-side potential.

GBP/JPY

Bank of England Warns of Brexit Risks

Created with Marketscope/Trading Station II; prepared by James Stanley

Another long-term support level has come into play of recent in EUR/GBP. A Fibonacci retracement can be set over the 16-year move in the pair, taking the low from the year 2000 to the high in 2008, and you’ll see numerous support and resistance inflections off of each of these Fibonacci values. A long-term support value of this nature can be really helpful in defining stance.

For traders looking to get short EUR/GBP, this may be a key level to watch for directional stance; as in, until this level is broken, indicating further bearishness in the pair, traders may want to approach short positions with caution.

If the Brexit vote does, in fact, come out on the side of status quo to remain in the European Union, this pair could see considerable weakness as Sterling strength comes back as the risk of leaving gets priced-out of the market. We’re taking a look at the past nine years of price action in EUR/GBP below, including the long-term trend-line that came into play as resistance just a month and a half ago.

EUR/GBP

Bank of England Warns of Brexit Risks

Created with Marketscope/Trading Station II; prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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