Pound Bulls May Be Emboldened If Carney & Co. Play Hawkish Tune

(Bloomberg) -- The pound may rise and gilts decline if the Bank of England signals a more hawkish tone this week after the recent Brexit deal breakthrough.

While BOE officials are not seen following their Nov. 2 tightening with any move on Thursday, sterling may gain to $1.35-$1.36 if policy makers acknowledge that the progress made in negotiations between the U.K. and European Union removes downside risks, according to ING Groep NV strategist Viraj Patel. Nomura International Plc agreed that there is a “tail risk” that the central bank is more hawkish and predicted this could drive up bond yields.

While the deal may not have a material impact on the BOE’s forecasts given officials presume a smooth Brexit transition, investors may focus on whether the Monetary Policy Committee reinstates the guidance it dropped last month that more rate increases could be needed than the market expects.

Here is a selection of views from analyst notes sent to clients:

Natwest Markets

  • “There is a material risk that the bank’s policy signaling will be deemed by markets to be more hawkish than in November,” strategists including Head of European Economics Ross Walker wrote in a note to clients
  • After the dropping of the reference to the potential for quicker-than-expected rate increases in their November minutes spurred a dovish market reaction, Monetary Policy Committee members may decide to send a more hawkish signal
  • “Current market pricing is very much toward the dovish end of the range, hence positioning for earlier or faster policy tightening looks attractive”
  • Recommends holding Feb. 2018/May 2018 MPC Sonia steepeners

Nomura International Plc

  • “With positive noise from the Brexit negotiations, this may increase the tail-risk chance that the MPC is more hawkish than expected on Thursday,” said analysts including head of European rates strategy Andy Chaytor
  • See gilt yields rising into year-end, “potentially helped if some hawkish risks around the MPC materialize next week”
  • Positioning for this via steepeners out to 10-year

ING Groep NV

  • “Brexit progress and solid data may unlock some hawkish BOE sentiment,” currency strategist Viraj Patel wrote in a note
  • Whether the MPC acknowledges recent Brexit developments is key
  • The pound will be supported by the risk of a no-deal Brexit being taken off the table, and “there is a good chance of any hawkish BOE commentary propelling GBP/USD up toward the 1.35-1.36 area this week”

Scotiabank

  • If policy makers do reintroduce their line on the potential for a faster-than-expected pace of tightening, “then the gilt market is likely to sell off from these current levels,” according to economist Alan Clarke

Citigroup Inc.

  • “This meeting may not in itself be a market mover, but it will set the scene for monetary policy ahead of the February Inflation Report,” Jamie Searle, a fixed-income strategist at the bank, said in a note to clients
  • Sees December as too early for a change to the MPC’s thinking
  • Still, 2s10s gilt flatteners offer attractive risk-reward for the medium term
    • This reflects “the cap on long-end yields from Brexit uncertainty and the upward pressure on front-end yields from the MPC looking to hike if conditions allow”

JPMorgan Asset Management

  • “Nothing is expected from the BOE so soon after they increased interest rates last month and signaled that a very slow pace of further tightening would be appropriate,” Mike Bell, a global market strategist at the asset manager, said in emailed comments
  • Doesn’t see the progress in Brexit talks to affect the MPC’s outlook as they were “already implicitly assuming in their forecasts that the U.K. would avoid a no-deal Brexit”
  • “Sterling is likely to continue to be driven more by news related to the Brexit negotiations, with securing a transitional deal the next key hurdle to maintain the pound at these levels”

©2017 Bloomberg L.P.

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