Bank of England To Cut Rates And Add To QE In Fourth-quarter Says UBS

Falling real incomes have put a squeeze on consumption, while declining business investment will eventually hit the labour market, says UBS.

The Pound could set for further losses going into year end if the latest contrarian call from UBS strategists is correct and the Bank of England dives deeper into the punch bowl in fourth-quarter.

Mark Carney and the monetary policy committee are likely to cut the bank rate to 0.10% over the coming months and add further to the BoE's already-expanded quantitative easing program, according to the Swiss bank.

“Since the outcome of the EU referendum, the UK economy has benefited from a weak sterling, performing much better than previously expected by the central bank and the markets,” says John Wraith, a rates strategist at UBS. “However, the trajectory still points to a slowdown in growth and we believe the economy is set to soften.”

Wraith recommended in February that clients enter a swaps trade, on the back of his thesis, that pays out if 30 Yr UK government bond prices outperform relative to their German and US counterparts.

That trade walked straight into a renewed bout of Sterling weakness and a strong performance from UK government bonds. Wraith reiterated his recommendation Thursday, sticking with his prediction that the BoE will ease further in Q4.

“Alongside accelerating inflation in the near-term, the UK economy is set to soften as a slowdown of private sector investment and corporate spending materializes, while consumption is hit by the decline in real earnings growth,” Wraith wrote in his earlier note.

The British Pound relative to other G10 currencies in 2017. Source: Pound Sterling Live.

UBS’ prediction of Bank of England policy is a contrarian call because, with the Pound under severe pressure relative to much of the G10 basket and inflation still running high, some economists are now calling for a hike while the consensus is for the next move in Bank Rate to be upwards.

Bank of England rate setter Michael Saunders said again in August that rates are too low and, although a well known hawk on the monetary policy committee, his statement was notable because rather than being ignored it was followed by renewed discussion of when the BoE may eventually act.

“The Bank of England’s job is done...Brexit is not enough to keep rates on hold,” wrote Berenberg economist Kallum Pickering in a note last week. “We look for a first rate hike in November 2017.”

Others have forecast a rate hike from the Bank of England in 2018.

“Alongside accelerating inflation in the near-term, the UK economy is set to soften as a slowdown of private sector investment and corporate spending materializes, while consumption is hit by the decline in real earnings growth,” says Wraith.

The latest Halifax House Price index showed UK home prices growing faster than was expected in August, with transaction activity appearing to stabilise after an earlier slump, easing fears of an imminent crunch in the housing market.

However, more forward looking indicators such as the IHS Markit PMI surveys of the manufacturing, construction and services sectors underlined a nascent slowdown in the key parts of the economy during the month of August - placing a question mark over the likely pace of growth in the third quarter.

This, combined with a firming recovery in the Euro area, has inflicted heavy losses on the Pound-to-Euro exchange rate during recent months - losses that could grow further if the BoE cuts again and the European Central Bank pushes ahead with its tapering agenda.

GBP/EUR exchange rate. Source: Netdania.

The Pound-to-Euro exchange rate was quoted 0.05% lower at 1.0932 shortly after noon Thursday, making for a Euro-to-Pound exchange rate of 0.9145.

The US-Dollar-to-Pound exchange rate was quoted 0.40% higher at 1.3094 Thursday afternoon.

Sterling also gained over a fair portion of the remaining G10 basket Thursday.

The Pound-to-Australian-Dollar rate was 0.15% higher at 1.6312 at the other end of the morning session and the Pound-to-New-Zealand-Dollar rate was up 0.32% at 1.8166.

The Loonie, however, continued to claim new ground from the British currency in the wake of Wednesday's rate hike from the Bank of Canada, pushing the Pound-to-Canadian-Dollar rate down by 0.14% to 1.5940.