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UK Weekly Market Analysis
BoE Delivers on Stimulus Guidance, GBP Craters

David Starkey August 5, 2016

Last month the Bank of England (BoE) surprised markets by not loosening monetary policy following the sudden increase in political and economic uncertainty from UK’s historic decision to exit the EU. Instead, policymakers stated that while they expected to loosen policy soon, they didn’t want to make any knee-jerk reactions. Since then data has confirmed economic obstacles. For example this week Purchasing Manager Index statistics revealed that the outlook for the manufacturing, construction, and service sectors has plummeted to multi-year lows. Accordingly, the BoE made good on its promise.

On Thursday at its Quarterly Inflation Report (QIR), BoE governor Mark Carney and his team again sounded alarm bells. They warned that the decision to exit the European Union poses a substantial short-term risk to the domestic economy. As such the BoE has slashed its forecasts for GDP growth; specifically, it flagged the labour sector as well as corporate & household spending as areas of concern. In response to the new outlook and in an effort to support the economy during these uncertain times the BoE announced a 4-point stimulus plan.

Firstly and effective immediately the benchmark lending rate has been cut for the first time 7-years, to an all-new low of +0.25%. Next the BoE is restarting its QE program, adding both £60-billion of Gilt purchases and £10-billion of Corporate Bond purchases. Finally, the BoE rolled out a new “Term Funding Scheme” (TFS). The TFS program is meant to facilitate the transmission of monetary policy easing to the high street. An issue observed during the global financial crisis was that in a near-zero interest rate environment policy changes were often diluted by the financial system. For example, if a central bank cut the benchmark lending rate by 0.5%, the rates on floating loans sold to retail consumers decreased by some amount lesser than 0.5%. To ensure a high degree of pass-through, the ‘TFS’ will allow qualified banks to borrow directly from BoE at preferential rates.

Further cementing the accommodative tone, during the press conference Carney noted at any time, should the BoE deem in necessary, it may expand stimulus measures further. Moreover, he confirmed members of the BoE’s rate-setting committee expect that the benchmark lending rate will decline further towards zero before the end of the year. However, when quizzed directly about negative interest rates, like those in Switzerland, he said he was “not a fan”.

Negative interest rates or not, the BoE has dug deep into its policy toolbox and wants markets to know that if necessary, it’s ready to do more. Unsurprisingly, the British Pound has taken to news badly and is set to end the week lower. Sterling has slipped back towards post-Brexit lows against virtually all of its major peers. Should support levels from late June/ early July fail in the days and weeks ahead, another leg lower could materialise. Specifically, against the USD, bank banks have been lamenting the risk of a move down to 1.25 or beyond.

Outside of the BoE activity, this week also saw the release of American labour statistics, which were broadly encouraging. Non-Farm Payrolls printed +255k versus expectations of +180k and Average Earnings advanced at a rate of +0.3%, a notch better than the +0.2% expected. The results are a signal that the USA might be bouncing back from disappointing Q2’16 economic data.  USD was broadly bid on the results and is set to end the week stronger as currency markets contemplate the possibility of an interest rate hike from the US Federal Reserve by the end of 2016.

Next week is a fairly light week when compared with the data ridden week that just passed. The only major piece data in the UK is the Manufacturing Production figure. Data is expected to reveal that growth in the sector pulled back to +1.5% year-over-year from last month’s +1.7% reading. Outside of the UK, on Friday the Eurozone Q2’16 GDP figures are slated for release. The consensus forecast is for +0.3% quarter-over-quarter growth, matching the Q1 result. All eyes will be on the contribution from Germany to the overall figure given the Germans boast the largest economy in the Eurozone.

Friday also sees the release of a trio of American data points: Retail Sales, PPI, and Consumer Sentiment. US Retail Sales figure, forecasted at +0.3%, down from the +0.6% seen last month. Meanwhile, US Consumer Sentiment is forecasted at 91.3, up from last month’s figure of 90.0. Given recent weakness in American GDP and softening Fed rate expectations, the big dollar might be especially sensitive to negative results.

Beyond the events highlighted above, currency markets will likely take broader direction from Brexit related uncertainty, which still rules the markets and is likely to for a while yet to come.

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