BoE: Probability of Rate falling to zero percent after yesterday’s inaction has fallen - MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that like the majority of the market, we were surprised by the decision of the MPC yesterday to leave Bank Rate unchanged at 0.50% - a decision that had the obvious impact of strengthening the pound.

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The GBP/USD high today of 1.3481 is the highest level since 30th June and 5.3% higher than the intra-day low set on 6th July. But the scope for the pound gaining much more from here looks limited to us.

The logic of delaying appears clear from the statement that was released with the decision to leave policy unchanged – an action that itself is unusual when policy is left unchanged. The MPC explained that “most members” of the MPC “expect monetary policy to be loosened” and that the “precise size and nature of any stimulus” would be determined based on the information provided by the Quarterly Inflation Report. So while the probability of Bank Rate falling to zero percent after yesterday’s inaction has fallen, the markets will certainly not discount that probability too much given the MPC will deliberate the “precise size” of easing at the next meeting on 4th August. The reserved response to the policy inaction in the rates market is telling – the 2-year Gilt yield increased a mere 2.5bps yesterday while the December 2017 short-sterling contract fell 6bps.

Another factor that might have played into the decision to wait was the rapid developments on the political front in the 48hrs ahead of the decision being announced yesterday. From assuming a political vacuum would exist until early September would have meant there would be no clarity on government policy between yesterday’s MPC meeting and the next on 4th August. However, the sudden end to the Conservative leadership election and a new government being put in place meant that much greater clarity on government policy could exist by the time of the meeting on 4th August. Chancellor Hammond did meet with Governor Carney yesterday to have an initial discussion on a way forward to stabilise the economy.

But the confidence of the MPC to explicitly signal easing on 4th August points to the Committee already seeing enough evidence to justify action. A whole host of data indicate a sharp drop in confidence that will no doubt become evident in the hard data in the coming months. The RICS Housing report yesterday was pretty grim with the Sales Expectations index plunging from -5 to -26, the weakest reading since the data series began in 1998. The flow of grim economic data from the UK is unlikely to change any time soon.

So we believe the upside for the pound from here is very limited. Pound buying this week may also have been helped by the speculation of ‘helicopter money’ being considered in Japan, which has fuelled heavy yen selling. GBP/JPY was one of the most volatile currency pairs around the Brexit vote and short pound versus the yen positions have no doubt been unwound. We are sceptical of ‘helicopter money’ becoming a formal reality any time soon and hence there is scope for disappointment and for renewed yen strength, which will take one source of pound buying this week out of the equation.”