In case you were too busy celebrating your bitcoin gains, you should know that the Bank of England (BOE) just went through another of its “Super Thursdays” that caused ruckus on the pound’s price action.
What exactly did BOE head honcho Mark Carney and his gang say? Here are takeaways you need to know:
No policy changes
As expected, the BOE’s Monetary Policy Committee (MPC) left its policies unchanged for another month:
- Bank rate remains at 0.25% (7-1 vote),
- GBP-denominated corporate bond purchases will still total up to £10 billion (8-0 vote), and
- The stock of UK government bond purchases will remain at £435 billion (8-0 vote).
Not surprisingly, MPC member Kristin Forbes maintained her vote to call 25-basis point interest rate hike. If you recall, Forbes isn’t too comfortable that inflation is “rising quickly” especially when downside risks of rate hikes have yet to materialize.
Oh, and if you’ve noticed, the MPC gang is short one member this month. This is because member Charlotte Hogg said “Cheerio!” as deputy governor in March when it was discovered that she failed to disclose a conflict of interest.
So if it’s not policy changes, what exactly did the pound react to during the event?
Winter is here
Well, at least for U.K.’s consumers. In his presser, Mark Carney implied that the Brexit-triggered slowdown has started and warned that “This will be a more challenging time for British households over the course of this year.” Duhn duhn duhn.
Carney was talking about the BOE’s estimates that “wages won’t keep up with prices for goods and services,” at least not while “businesses are hesitating to bring in higher wage costs at a time of some uncertainty about market access and other costs that could be associated with the Brexit process.”
See, consumers are now feeling the pinch as the pound’s post-Brexit weakness pushes prices of imported goods higher. Even worse, prices are currently rising faster than wages are!
As of last reading, inflation is at 2.3% while wages are only rising by 2.2%. Basically, Brits now have less to spend for discretionary items, which would weigh on overall GDP.
Fortunately, the BOE doesn’t expect the slowdown to go on for long. Carney shared that “The factors currently weighing on wage growth are unlikely to persist,” and that “wages will rise significantly as the output gap narrows throughout the forecast period and closes by the end.”
Deputy Governor Ben Broadbent echoed Carney sentiments, saying that “The squeeze that’s coming from rising import prices doesn’t last forever… it does sort of dwindle over the forecast period and that contributes to a rise in income growth in real terms.”
Revisions, revisions everywhere
After consecutively upping their economic forecasts for months, Mark Carney and his gang are now dialling down their expectations.
The U.K. economy is now expected to grow by 1.9% in 2017, a smidge lower than February’s 2.0% growth estimates.
We don’t have far to look for the reasons. In its inflation report the BOE pointed to slower consumer growth, which is “projected to remain weak over 2017 as higher import prices weigh on households’ purchasing power.”
The BOE upgraded its forecasts for 2018 and 2019, though, citing stronger path for global growth and some fiscal stimulus from the March budget report. Of course, it also doesn’t hurt that the dip in consumer spending has been partially offset by rising trade and investment activities.
The MPC upgraded its inflation forecasts for 2017, which Carney explains “entirely reflects the effects of import prices and weaker sterling.” Meanwhile, announced increases in utilities prices as well as higher commodity prices are also expected to contribute to higher inflation in the near term.
Though the central bank lowered its CPI estimates for 2018 and 2019, it also warned that “the path for inflation in coming quarters will depend on the speed and extent to which companies pass through rising external costs to consumer prices.”
Much like with inflation, the BOE believes that wage trends will likely depend on how businesses react to near-term uncertainty outlook (read: Brexit).
While it has downgraded its unemployment forecasts, it also cautioned that the recent declines in unemployment have been “accompanied by a rise in inactivity in the labour market,” so this may not necessarily point to a reduction in slack.
Overall, the MPC believes that unemployment would have to “fall further” before wage growth returns to more normal levels and that, given the subdued outlook for productivity growth, wage growth is likely to remain below pre-crisis average rates before it recovers “significantly” over the forecast period.
Assumption of “smooth Brexit”
Perhaps the biggest trigger for pound playas during the BOE’s announcement was the fact that the central bank priced in a “smooth Brexit” in its estimates.
The MPC noted that (emphasis mine):
“The projections in this Report continue to be conditioned on the average of a range of possible outcomes for those arrangements and, as before, the assumption that the adjustment to the United Kingdom’s new relationship with the European Union is smooth.”
When asked about it, Carney qualified that “It means there will be an agreement as to future trading arrangements and there will be a transition or an implementation period to that new agreement.”
The BOE hasn’t considered a plan B either. When asked what they would do in case of a disorderly Brexit, Carney admitted that “We would have had to do an alternative forecast with some variant of a disorderly negotiating process, and we have not done that.” Yikes!
Pound bears attacked
At least for an hour or so. Traders were NOT happy that the BOE had priced in a smooth Brexit in its forecasts especially given how unsmooth Brexit negotiations have been so far.
The pound’s selloff lacked teeth, however, because Carney and his gang also noted that “monetary policy will need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections” if their projections are on point.
GBP/USD hit a low of 1.2849 before recovering to 1.2890, GBP/JPY dropped to 146.17 before rising back up to 146.74, and EUR/GBP shot up to .8452 before falling back down to .8428.
For now, it looks like market players are willing to buy the BOE’s optimism that the Brexit process will be “smooth.”
But all that is still a big IF. If next month’s elections go as May’s Conservative Party pulls off a successful elections next month and manages to snag sweet deals with Britain’s major trading partners, then we might see the pound extend its gains against its major counterparts.
But if the BOE once again misses its Brexit-related estimates (this time underestimating its negative impact), then the pound could see big retracements, if not full on reversals.
In any case, make sure you watch out for any headlines that might affect the BOE’s “smooth Brexit” estimates!