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British Pound May Rise on Status-Quo Bank of England Inflation Report

Fundamental Forecast for British Pound: Neutral

  • All Eyes Are on the BOE Quarterly Inflation Report in the Week Ahead
  • British Pound May Correct Higher Absent Major Dovish Rhetoric Shift
  • Help Identify Critical Turning Points for GBP/USD with DailyFX SSI

The outlook for monetary policy continues to be the dominant driver of British Pound price action. Indeed, the correlation between GBPUSD and the UK 2-year Gilt yield – a reflection of investors’ near- to medium-term interest rate outlook – is now at a formidable reading of 0.73 (on rolling 20-day studies).

Last week’s BOE announcement proved to be a non-event, with Governor Mark Carney and company leaving the setting of monetary policy unchanged and publishing no explanatory statement to lay out their reasoning going forward.

The week ahead ought to be more eventful as the central bank unveils its quarterly Inflation Report. The document and the press conference following its publication have served as the primary vehicle for officials to communicate major changes in their outlook for the economy and introduce changes into the policy mix.

A shift in strategy this time around is unlikely: February’s re-tooling of the “forward guidance” framework to focus on the loosely-defined objective of reducing spare capacity has arguably left enough space to maneuver for the rate-setting MPC committee such that it can adjust its posture without scrapping the policy regime entirely.

That means investors’ primary points of interest will be any updates to the BOE’s economic forecasts and the tone of its rhetoric. Needless to say, these will be evaluated in an attempt to gauge when the bank might feel comfortable raising interest rates.

The markets’ hawkish policy outlook moderated significantly in July, with GBPUSD marching lower alongside front-end yields to break its 2014 uptrend and finish last week with the weakest close in two months. As we argued a month ago, that makes sense. UK economic data outcomes have tended to underperform relative to consensus forecasts since February, suggesting that building a hawkish voting majority on the MPC will be a tall order in the near term.

With that in mind, Sterling has now fallen for five consecutive weeks. This suggests that the Inflation Report will probably need to deliver an outsized dovish surprise in to maintain momentum behind the down move. On the other hand, a status-quo outcome may paint the recent selloff as a bit one-sided, opening the door for a corrective bounce.