"Cacophony Problem" at BoE Anchors British Pound, Forecasters Hold Targets v Euro and Dollar Despite Prospect of 2017 Rate Rise

It's deadlock for Pound Sterling at present.

The currency remains caught in an incredibly tight range against the Euro and Dollar as traders over the course of the past week with the Pound to Euro exchange rate opening at 1.1386 and closing the week at 1.1358.

The Pound to Dollar exchange rate started the week at 1.2763 and clsing the week at 1.2716.

These exchange rates have hardly moved in weeks.

Behind the apparent deadlock is a wait-and-see approach amongst traders waiting for Brexit negotiations to give them some meat to chew on. 

But it is the Bank of England's mixed message concerning future interest rates that appears to have tightened the deadlock.

Above: Weekly charts for GBP v EUR show the pair has hardly moved in three weeks now.

Above: GBP v USD going nowhere fast suggests the weekly chart.

Unity amongst the decision-makers at the Bank of England is in short supply at present with a notable split emerging between those in favour of raising interest rates, and those against.

More importantly, the split extends to the Monetary Policy Committees two ‘big guns’ - Mark Carney is for keeping rates unchanged, Chief Economist Andy Haldane is for raising rates.

That the Bank is actually the closest it has been to raising interest rates since 2007 would typically be positive for the Pound as currencies tend to rise in interest rate raising cycles.

But the split has actually seen Pound Sterling enter a state of paralysis - it is sticking to an incredibly tight range against the Euro and Dollar.

“Conflicting messages from key BoE officials this week have left markets in a state of confusion when it comes to understanding what UK monetary policy means for the Pound,” says Viraj Patel, Foreign Exchange Strategist at ING Bank NV in London.

Intriguing insights into this paralysis at the Bank were given by outgoing MPC member Kristin Forbes in her final speech in which she said central bankers were afraid of taking big, potentially unpopular, decisions on interest rates in order to protect their public image.

“As central banks have seen their remit expanded to include a broader set of considerations and have played a more public role, this could make them more hesitant to ‘Take away the punch bowl’ and make the difficult decisions that can be required to keep inflation stable,” said Forbes.

Above: Kristin Forbes suggested her colleagues at the BoE might be afraid of the damage to their public image were they to raise rates too early.

She adds, "over my term on the MPC, we have been much quicker to adjust monetary policy in response to downside risks than upside."

In short, Forbes says her fellow Committee members are just too scared of inviting criticism by raising interest rates that are too low.

Nevertheless, some in the markets believe the Bank will show some bravery with analysts at Nomura raising eyebrows on Thursday, June 22 with the suggestion that an interest rise could come in the August meeting.

For others, November appears to be a more realistic date for a 0.25% rate rise.

"While we maintain our view that the Bank Rate will be unchanged over our forecast horizon (2017­-18) given our lower growth profile relative to the BoE, we believe that the risks of a +25bp rate hike in November 2017 have increased mainly because we see Haldane as one of the more influential MPC members,” says Fabrice Montagne at Barclays.

Higher interest rates tend to lead to a rising currency as global investors send money to jurisdictions that command a higher return on their capital.

Limited Impact on the Pound's Outlook

But ING’s Patel argues that even if the Bank were to raise rates 0.25% in 2017 it would have a very limited impact on the Pound.

“The bottom line is that nothing has changed and even under the most hawkish of scenarios – that the post-Brexit 25bp rate cut is reversed later this year – a very shallow Bank Rate path means that a sustained period of GBP appreciation is unlikely,” says Patel.

ING expect a slowdown in the UK economy should make the case for rate hike less compelling.

Indeed, Governor Carney stated on June 20 he wants to see inflation - the kind generated by wages and not one-off devaluations in the Pound - rise:

“Given the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time to begin [raising interest rates]… [we need to see] how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.”

The BoE’s “Cacophony Problem” = GBP Volatility

It’s clear that the June policy meeting – and subsequent speeches by key officials – have highlighted the independence of the BoE.

"An MPC with diverse views is not necessarily a bad thing – and central bank transparency should not be knocked back. But there is an optimal level of transparency," says Patel.

The purpose of central bank communications is to make monetary policy more predictable but former Federal Reserve Vice-Chair Alan Blinder once warned that too much talk can create a “cacophony problem” – where an MPC that speaks with a range of views could ultimately end up having “no voice at all”.

Patel says with greater policy uncertainty ultimately comes increasing (not decreasing) volatility in rate-sensitive UK asset prices such as Sterling.

Watch the Data

Economists at UBS have also been thrown off-kilter by the latest developments at the Bank, but believe that ultimately upcoming data will do the talking.

Strategist John Wraith at UBS says he still expects weaker UK economic data to persist and ultimately lead the BoE to downgrade its own expectations and disarm the hawks, but the change in tone is for the time being set to introduce more two-way risk.

"Our forecast for more monetary easing in due course is clearly put at risk by these developments, but we stick to it for now while we assess incoming data to see if it supports our case, or that of the new and prospective MPC hawks," says Wraith.

Sticking to the Forecasts

ING believe that on balance there is no reason to update their forecasts on Sterling in light of the recent developments at the Bank.

“This slightly more bearish outlook means that our base case is still for GBP/USD to fall to 1.24 and EUR/GBP to move up towards 0.90 in the near-term,” says Patel.

EUR/GPB at 0.90 equates to 1.11 in Pound to Euro terms.

However, ING do concede that the Bank has put a floor underneath the Pound, for now.

“We prefer to look through the recent 'noise' coming out of the Bank. Bar any knee-jerk GBP moves that will arise from further mixed signals, we think at best the current neutral-hawkish BoE sentiment will put a floor under GBP/USD around 1.2550 and limit EUR/GBP upside to 0.8850,” says Patel.

Analysts at Barclays are meanwhile forecasting the GBP/USD exchange rate to end 2017 at 1.29 and EUR/GBP at 0.85 (1.1765 GBP/EUR).

UK Giving the EU What it Wants in Early Brexit Negotiations

With regards to the all-imporant issue of Brexit, thus far all the signs have suggested the UK is willing to move fast in order to get the intial stages of talks concluded.

In a major conceession the UK agreed to the EU's timetable that sought to agree on major sticking points such as the divorce bill, the Irish border and status of EU citizens living in the UK ahead of discussions on a trade deal.

This has since been followed by May confirming the UK would allow EU citizens to settle in the UK in order to avoid any uncertainty regarding their status.

“Hear, hear!” says David Johnson, founding director at currency specialists, Halo Financial. “It’s reassuring to see that first on the agenda for agreement includes the rights of expats – something that has been playing on our clients’ minds for well over a year. Whether that’s UK citizens retaining rights while living in the EU, or employers wishing to protect the rights of EU citizens in the workforce, this is a considerable cause for concern for many.”

Ultimately, for the Pound it remains all about Brexit.

The Bank of England will only be brave enough to raise interest rates in a more sustained fashion once clarity on the UK's future relationship with Europe becomes clear.

And that relationship must be good enough to ensure UK economic growth continues and wages keep rising.

If this becomes clear, then the Pound will finally break higher.