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Market Wire
Bank of England Stays on Hold, Currency Round-Trips

Karl Schamotta March 22, 2018

In its latest decision, the Bank of England Monetary Policy Committee voted by a majority of 7-2 to maintain its benchmark interest rate at 0.50 percent – and inched closer to raising rates at its May meeting. Policymakers Ian McCafferty and Michael Saunders cast votes for an immediate increase, backing their reasoning with evidence of accelerating wage growth and diminished economic slack.

Policymakers highlighted a supportive global growth backdrop, saying, “The prospects for global GDP growth remain strong, and financial conditions continue to be accommodative, with little persistent effect from the recent financial market volatility” – but Brexit-related concerns remained front-and-centre in keeping the Bank sidelined. “Developments regarding the United Kingdom’s withdrawal from the European Union – and in particular the reaction of households, businesses and asset prices to them – remain the most significant influence on, and source of uncertainty about, the economic outlook”.

Yesterday’s January labour report illustrated a solid jump in job creation, offsetting December’s losses and bringing the unemployment rate back down to 4.3 percent. Committee members acknowledged this improvement in labour market conditions, saying, “The firming of shorter-term measures of wage growth in recent quarters and a range of survey indicators suggest pay growth will rise further in response to the tightening labour market. This provides increasing confidence that growth in wages and unit labour costs will pick up to target-consistent rates”.

The decision largely met market expectations, with the announcement triggering a 30-basis point roundtrip in currency markets – but with odds on a May hike rising, pounds sterling are trading at a roughly-5-percent premium relative to levels that prevailed on January 1st.

The US dollar extended its post-Fed decline overnight, falling roughly half a percent on a trade-weighted basis. The tone coming out of Jerome Powell’s first policy meeting was unmistakably hawkish, but perceived changes in the central bank’s reaction function helped exacerbate the ‘sell on news’ dynamic that often accompanies a well-telegraphed decision. According to updated projections, the margin between three and four hikes this year was incredibly tight, with a single vote needed to put another increase on the table. Near term growth expectations also rose, but an articulated willingness to let inflation rise above target and allow the jobless rate to fall below previous full employment estimates suggest that the Federal Reserve is willing to let the economy overshoot before ratcheting policy tighter. Thus far, this commitment to gradualism is removing some of the risk premia embedded in interest rates and allowing the dollar’s counterparts to recover lost ground – but this could reverse as markets raise the odds on four hikes in the days and weeks ahead.

Bottom Line: Barring a major political reversal, Brexit-related issues are likely to fade into the background till autumn, clearing the way for a hike at the May meeting. However, with growth depressed and currency-related inflationary pressures easing, a second move looks unlikely in the near term. The pound’s upward momentum remains fragile.

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