British Pound Rally Fired up by Bank of England 'Super Thursday'

Above: Governor of the Bank of England, Mark Carney. Image © Simon Dawson, Bloomberg, Bank of England.

- Bank offers insurance against 'no deal' Brexit slump in Sterling

- British Pound surgest over 1.0% vs. Euro and Dollar

- Bank sees the Pound rising in event of a smooth Brexit transition being secured

Pound Sterling has surged over 1.0% against its key peers over the past 24 hours in a move that saw it breaking above 1.14 against the Euro and 1.30 against the Dollar; levels which would have been unthinkable a mere two days earlier.

The Pound has rallied on a combination of progress regarding Brexit negotiations and a hawkish message on the future of U.K. interest rates at the Bank of England that hints at a high probability of interest rate rising either once or twice in 2019.

The Bank said it could raise interest rates in 2019 whether the U.K. and E.U. strike a Brexit deal or not; this tells markets the Bank is willing to raise rates in the event of a 'no deal' Brexit in order to defend the value of Sterling in order to stave off a damaging round of rising inflation.

The Bank has therefore become something of an insurance policy against a major decline in the value of Sterling in the event of a 'no deal' Brexit.

Recall, the decline in Sterling following the E.U. referendum lead to a boost in inflation, something Threadneedle Street is keen to avoid in the event of a 'no deal' Brexit.

"It was the BoE’s openness to raising rates in the event of a no-deal Brexit which sent the Pound sharply higher, with markets largely ignoring the predictable interest rate freeze," says Joshua Mahony, market analyst with IG.

Standard thinking suggests that in times of economic stress an interest rate cut is called for, however according to Mahony a potential decline in the Pound means that the Bank has to choose between boosting growth with a rate cut, or easing inflation with a hike.

"It seems Carney and co are willing to stick to their core mandate of price stability, hoping that a rate hike would ease cost pressures, thus avoiding a sharp deterioration in real wages," says the analyst.

At the time of writing the British Pound is pushing higher against the Dollar, Euro and an host of other major currencies, adding to the gains realised following a string of rumours concerning Brexit negotiations.

The Pound-to-Euro exchange rate is quoted at 1.1409, up 1.12%, the Pound-to-Dollar exchange rate at 1.3012, up 1.91%. "GBPUSD +1.9% today. Since 2008, the pair rose more than 1.9% in only 4 other occasions. A sign of what exactly," says Ashraf Laidi, Strategist, trader & author of Currency Trading & Intermarket Analysis.

Delivering its November policy meeting the Bank announced it would leave policy settings unchanged with a 9-0 vote of the Monetary Policy Committee carrying the decision. This is in line with market expectations; we saw an outside chance that one or two MPC members would vote for a rate rise.

According to the minutes of the November meeting, the positives are offset by the negatives:

"Momentum in household consumption appears greater than previously expected, supported by the strong labour market and resilient household confidence.

"Over the forecast period, household consumption is expected to grow modestly relative to historical rates, broadly in line with real incomes. In contrast, business investment has been more subdued than previously anticipated, as the effect of Brexit uncertainty has intensified."

Meanwhile, the November Inflation Report proved mixed with some downgrades but a few crucial upgrades.

"The output gap closing & an economy running hot from late 2019 is generating further reductions in Sterling hedges I suggest. The BoE appears more hawkish than the market at a time when the FED & other central banks are gravitating in the same direction. Sterling will trade higher, but the upside should be limited given forecasts are based on a soft & orderly Brexit," says Neil Jones, a dealer with Mizuho Bank Ltd. in London.

????????#BankOfEngland maintains Bank Rate at 0.75% and sends now new policy signals. That said, this chart from the Inflation Report is very interesting! More companies think #Brexit is now the top source of uncertainty! Probably explains why investment growth is weak $EURGBP pic.twitter.com/EXIYpXNXTX

— Danske Bank Research (@Danske_Research) November 1, 2018

"Had a deal on Brexit already been signed and sealed, the MPC might well have raised interest rates today, given signs that wage inflation is finally picking up and the fact that the Chancellor announced in his Budget on Monday that taxes will be cut and public spending increased from next April," says John Hawksworth, Chief Economist at PwC.

PwC expect the Bank to continue with this 'wait and see' stance until a deal is agreed by all relevant parties including the UK and European Parliaments.

"If and when a deal on Brexit is agreed, however, the MPC is likely to resume raising rates next year unless there are other major adverse shocks to the economy," says Hawksworth.

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Inflation Report: Forecasts, Expectations for Sterling

Above: Watch the press conference.

According to the November Inflation Report, there is a slight downgrade to economic growth forecast for 2019 with a nudge lower to 1.7% from 1.8% previously. 2018 growth is maintained at 1.5% while 2020 growth is forecast at 1.7%.

Inflation forecasts for 2019 are downgraded to 2.1 from 2.2%. The 2020 forecast is upgraded from 2.0% to 2.1%.

However, 2018 inflation for the fourth quarter is upgraded to 2.5% from 2.3%.

"Even though their 2019 GDP forecast was revised slightly lower, the Bank maintains an above-consensus forecast over the years as well as above-target Inflation forecasts over the coming years," says Fabrice Montagne, an economist with Barclays in London.

The uptick in inflation forecasts appears to be the work of expectations for higher wage growth going forward.

"Growth in whole-economy and private sector measures of labour costs are projected to rise over the forecast period, supported by robust growth in regular pay. That leads to a gradual building of domestic inflationary pressures," says the Bank.

Concerning the outlook for the Pound, the Bank say they expect the currency to appreciate in the event of a smooth Brexit transition period being secured.

"In the case of a smooth transition to a relationship that is judged to have a relatively small long-term economic impact, financial market participants might expect a smaller hit to UK real incomes than currently, causing the exchange rate to appreciate.

"In contrast, a disruptive withdrawal from the EU could result in a more pessimistic view and some further depreciation."

Analyst Reactions

"A clean move to transition post Brexit will almost certainly lead to a Q1 hike, but a 'data dependant' Bank of England in 2019 is not one that bond investors should fear too much,” says Ben Edwards, Portfolio Manager of BlackRock's Corporate Bond and Sterling Strategic Bond Funds.

The Inflation Report supports the view of Ruth Gregory at Capital Economics that provided a Brexit deal is struck, market expectations are underestimating the pace of monetary policy tightening further ahead. "Inflation is now projected to be a little above its target at the two-year policy horizon, based on the market profile for interest rates of three hikes over the next three years."

Capital Economics now think that interest rates will rise three times in 2019, rather than twice, assuming a "no deal" Brexit is avoided.

Jameel Ahmad, Global Head of Currency Strategy & Market Research at FXTM says the BoE decision is "pretty much a non-event in markets - who can blame Carney & co when everyone is in wait-and-see mode regarding potential Brexit deal."

"The Bank is playing a supporting role in terms of Sterling sentiment," says David Lamb, head of dealing at Fexco Corporate Payments. “Brexit rumours now make much of the foreign exchange weather, not the Bank’s rate-setting grandees."

"With the prospect of fresh interest rate rises booted firmly into 2019, the markets are buckling up for a rollercoaster few weeks where the tone will be set by the all-consuming question of ‘deal or no deal’ on Brexit," adds Lamb.

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