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UK Market Analysis
“Modest Tightening” in Next Few Years Fails to Inspire GBP

David Starkey December 14, 2017

– ECB holds steady course

– Dollar slips as Fed falls short

– Quiet data calendar disguises historically volatile period on the horizon


Sterling softened modestly in the aftermath of the Bank of England monetary policy update this week. The rate-setting committee was unanimous in its decision to leave policy unchanged, which was in line with the consensus forecast. However, GBP didn’t respond well to the tone of the accompanying monetary policy statement. The statement highlighted that the BoE considers Q4 data results as “softer than expected.” Sentiment was further backfooted by a cautionary reiteration that the BoE expects only “modest tightening” in the years ahead, with rate hikes being “limited and gradual-.”

Overall sterling performance on the week has been on the disappointing side. Modest gains against currencies like USD and CAD are more than offset by losses against EUR, JPY, and antipodal currencies. A general malaise is setting in with respects to the British pound as progress in Brexit negotiations continues to be slow and hard fought. Concern is compounded by data, which now to shows that Brexit has shifted from a theoretical future risk to a present and measurable drag on economic performance.

The Federal Reserve hiked its benchmark interest rate this week as anticipated. However, the greenback is weaker in the aftermath since the Fed’s 2018 outlook fell short of expectations. Markets were of the opinion that given healthy GDP and low unemployment alongside the possibility of dramatic fiscal stimulus (President Trump’s tax reform package), the Fed would be more ambitious. Policymakers, on the other hand, chose to err on the side of caution. According to the official projections, only three rate hikes in 2018 make up the base case, matching 2017’s policy tightening activity. Markets were holding out for four hikes and the disappointment has led to some position trimming. The Dollar Index, which tracks USD on a trade-weighted basis, is lower by about 0.5% on the week at the time of writing.

Rounding out the trifecta of monetary policy updates this week was the European Central Bank. Similar to the BoE, the ECB left policy unchanged this time around. Furthermore, guidance confirmed that ultra-loose monetary policy will continue. The ECB specifically noted that despite recently tapering its QE, that course can be reversed and the program both extended and expanded as needed. This reflects previous comments from the ECB and the common currency is largely unchanged at the time of writing.

Next week’s data calendar is fairly light. Final Q3 GDP results for both the UK and USA could generate volatility, but only if the published number differs from preliminary readings.  Otherwise, as has been the case in the past, it could be a non-event. Furthermore, on the Brexit front, the likelihood of new developments appears limited between now and year-end. The EU Council goes on break as of this Friday’s “Material Progress” deadline until March 2018. After marathon meetings in recent weeks to insure that hurdle is cleared, a period of cooling off could be in store.

While currency markets probably won’t, in the coming days, have the Brexit and central bank-related excitement of the last few weeks, it doesn’t mean rates will be on autopilot into the New Year. The combination of thin holiday markets and year-end flows could make for choppy price action, as has been the case historically. For example from December 15 to the first trading week in January 2014, 2015, and 2016 GBPUSD had a range of approximately 5%. Over the same three-year period, the range for GBPEUR from mid-December to mid-January looked more like 6%-8%, making that period amongst the most volatile on the calendar. It could be a dangerous time for complacency with respects to currency exposure management.

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