Yesterday the Bank of England (BOE) finished off the parade of major central banks publishing their monetary policy decisions for the week. And boy, did it end the program with a bang!
What exactly did the BOE say and why did forex market players react so strongly at the release? Here are 4 things you need to know:
No changes to current policies
Whatever action happened did not happen because the BOE surprised market players with monetary policy changes:
- The bank rate remains at 0.25%,
- GBP-denominated corporate bond purchases will still total up to £10 billion, and
- The stock of UK government bond purchases will remain at £435 billion.
So what caused all the ruckus?
One member voted for a rate hike
You read that right! Monetary Policy Committee (MPC) member Kristin Forbes surprised market players yesterday by voting for a 25-basis point interest rate hike when analysts had been expecting a clean 9-0 vote on the matter.
Apparently, Forbes is not convinced that the BOE should continue shrugging off high inflation expectations in favor of stimulating the economy. If you recall, Mark Carney and his team announced last month that the BOE is willing to tolerate high inflation because raising rates would curb employment and economic activity.
But according to Forbes, inflation was “rising quickly” and is “expected to remain above target for at least three years.” Domestic measures of inflation have also “increased notably” while global reflation and minimal labour market slack are posing “upside risks to inflation.”
Meanwhile, Forbes also pointed out that the downside “risks” of a rate hike have yet to materialize. The economy hasn’t fallen to its doom (at least not yet) since the EU referendum and unemployment is not increasing. And while consumer spending has taken hits as expected, other GDP components (such as net exports) can pick up the slack.
We might see a rate hike sooner than we thought
In February’s Super Thursday, Mark Carney took care to note that the BOE can “see scenarios in either direction” when it comes to policymaking.
This time, he detailed that “monetary policy may need to be tightened sooner and to a greater degree” if “aggregate demand growth remains resilient” while “a more marked slowdown in activity could warrant additional policy support.”
The MPC also shared three conditions that they pinned their February forecasts on:
1. Weak GBP will boost consumer prices
2. Pay growth remains modest
3. Household spending growth will slow down as real income gains weakened, without a sufficient offset by other components of demand.
For now, MPC members believe that last month’s projections are still “broadly on track” so their plans to modestly withdraw stimulus over the course of the forecast period remain appropriate.
Inflation is still expected to rise above the 2% target over the next few months and peak at 2.75% before gradually falling back. Meanwhile, the current 4.7% jobless rate is still around the BOE’s unemployment rate 4.5% estimates.
But some members have already noted that it would take little to push them into Forbes’ hawk camp. Specifically, (emphasis ours):
The potential for uncertainty over future trading arrangements to affect materially economic decision making remained, posing a downside risk to the activity outlook, to which the Committee could respond if necessary.
On the other hand, with inflation rising sharply, and only mixed evidence on slowing activity domestically, some members noted that it would take relatively little further upside news on the prospects for activity or inflation for them to consider that a more immediate reduction in policy support might be warranted.
Pound bulls attacked
Kristin Forbes’ decision to vote for a rate hike, as well as the MPC members’ hints of maybe raising rates sooner than we expected, surprised market players who were mostly expecting more of the same from last month plus maybe a cautious word or two about the impact of a Brexit.
GBP/USD hit an intraday high of 1.2377 before closing with a 60-pip (+0.49%) gain to 1.2357, GBP/JPY jumped by 69 pips (+0.50%) to 139.93, and EUR/GBP dropped to a low of .8669 before overall EUR strength pushed it back up to .8714.
While the majority of MPC members are willing to stick to their guns and continue stimulating the economy, it looks like they’re also ready and willing to back to their hawkish ways as soon as the economy’s downside risks *cough* Brexit *cough* have decreased.
If the Brexit process is less painful to the economy than everyone and his momma have feared, then we might see the BOE raise its rates sooner than we thought.
But if it leads to an even weaker currency (and higher inflation), more unemployment, and overall uncertainty, then Kristin Forbes may be an alone hawk for a while yet.