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British Pound May Rise Following the BOE Inflation Report

British Pound May Rise Following the BOE Inflation Report

2015-02-07 00:27:00
Ilya Spivak, Head Strategist, APAC
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British Pound May Rise Following the BOE Inflation Report

Fundamental Forecast for British Pound: Neutral

  • British Pound Looks to BOE Inflation Report for Direction Cues
  • Carney & Co May Revive Rate Hike Bets, Boosting UK Currency
  • Help Find Key British Pound Turning Points with DailyFX SSI

The Bank of England interest rate decision produced no changes in policy last week, leaving the British Pound without guidance on where Governor Mark Carney and company intend to steer going forward. The markets will look to dispel this uncertainty in the week ahead as the central bank publishes its quarterly Inflation Report. Officials have used the document and its accompanying press conference as the primary vehicle for announcing policy and outlook changes over recent years.

As we discussed in our first-quarter forecast, sinking Eurozone economic growth expectations have weighed heavily on BOE interest rate hike expectations since mid-2014. This is not surprising. The Eurozone is the UK’s largest trading partner: the share of total exports headed for markets on the Continent has been on the rise and is now hovering near a two-year high of 48 percent. That means that even as the UK economy has recovered from the 2008-09 recession, its sensitivity to headwinds from the Eurozone has increased.

With this in mind, it is no wonder that Mr Carney has recently remarked that policy normalization may come slower than previously expected. That much is likely to be reflected in the BOE’s updated forecasts for growth and inflation, both of which will probably edge lower. The larger question is whether this is likely to weigh on the British Pound.

The currency has been trending firmly lower alongside fading tightening bets for months, so much of the negativity to be expressed in the Inflation Report may be priced in already. Indeed, backing out priced-in expectations from Sterling interest-rate futures reveals traders don’t envision a hike sooner than the fourth quarter. OIS-based indications are even more pessimistic, pointing to no tightening until at least the beginning of 2016.

On balance, this suggests the British Pound may be disproportionately more sensitive to a hawkish surprise in the central bank’s rhetoric than a dovish one. The currency may not suffer too badly if the markets’ unwinding of rate hike bets is validated. If policymakers firmly remind investors that the BOE does not intend to join the increasingly wide-spread lurch toward stimulus expansion and maintain the next policy change will be to reduce accommodation, the UK unit may rise.

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