Pound Fate to Hinge on Carney Keeping 2018 Rate Hike Alive

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(Bloomberg) -- It’s not what the Bank of England does on Thursday, but what it says that may hog the headlines -- and set the pound’s fate.

With money markets having already priced out an interest-rate increase, investors and traders will be parsing the language of the statement to decide whether it’s a hawkish hold or a dovish intent that will determine the possibility of a hike later in the year. The former will lead to a sterling recovery after the currency’s slump in the past month, strategists say.

A rate hike looked a certainty in sterling assets just a few weeks ago until a string of disappointing economic data and Governor Mark Carney’s warning that a May hike was far from certain. With money markets now pricing a next rate hike for December, the yield on 10-year gilts has dropped more than 20 basis points from a February high of 1.69 percent.

“The immediate gilt market reaction will be determined by whether the Bank of England delivers a “hawkish hold”, or whether it is starting to show signs that it shares our more pessimistic outlook for the economy,” said Daniela Russell, HSBC Holdings Plc’s head of U.K. rates strategy. The bank sees any weakness as an opportunity to add to long positions at the front end of the gilt curve.

BOE Watchers Complete About-Face as May Hike All But Ruled Out

The pound hovered around the $1.35 level on Wednesday, after reaching $1.43 last month. Its recent slide has wiped out almost all of the gains made this year against the dollar. Hedge funds have pared back their long sterling positions.

Investec Bank Plc’s Chief Economist Philip Shaw predicts the currency could get a short-term boost as the BOE keeps its options open on future hikes, while Mizuho Bank Ltd.’s Neil Jones doubts there will be any hawkishness and said the pound could slip toward $1.30 this year if Brexit talks sour.

Following are various analyst views on the BOE meeting:

ING

  • “Recent wild swings in GBP are somewhat indicative of an “all or nothing” sentiment when it comes to further BOE rate hikes,” according to currency strategist Viraj Patel
    • The “all” scenario “being two or more rate hikes in 2018 versus ‘nothing’ being that the Bank will not hike again”
  • The decline in sterling to $1.35 “looks overcooked relative to the more tempered BOE policy rate expectations,” he says
  • “Cleaner positioning and relatively limited sentiment for additional downside means that the risk-reward favors GBP/USD upside going into the May BOE meeting”
  • “Signs that the BOE tightening cycle remains intact could lift GBP/USD up toward 1.3600,” Patel predicts

Investec Bank

  • Sterling seems to be pricing in a “dovish Inflation Report, with lower GDP forecasts and few hints of further rate increases,” says Investec’s Shaw
  • “It seems more likely that the MPC will keep its options open, suggesting that the scale of the recent slowdown is temporary and suggesting that it will raise rates again over the coming months”
  • If so, the pound may get a degree of support from its lows. Indeed it would seem very strange if recent data volatility completely killed off the process of policy normalization
  • “Another important point is how the BOE explains the faster-than-expected fall in inflation this year”
    • Shaw says it is more likely due to the rapid fall in sterling “than big disinflationary pressures in the system and we would expect the BOE to concur”

Mizuho Bank

  • Mizuho is expecting no change on Thursday and Jones says sterling “should remain overall offered into and beyond the meeting”
  • BOE could stay on hold now until beyond March 2019, just to see how Brexit plays out, he says
  • “Indeed, if there is a no deal I would expect the BOE to cut, just as they did after the referendum”
  • Given the recent spate of disappointing U.K. economic data, political issues continuing to weigh on confidence, Jones says the slide in GBP/USD is “unlikely done yet”

HSBC

  • Regardless of what knee-jerk response there is, HSBC’s Russell says “bond yields are set for a period of choppy consolidation in the coming weeks”
  • Recommends entering 10s30s gilt curve flatteners
    • The trade “offers some diversification to our existing portfolio and – if yields do consolidate from here – we could start to see the curve flattening into next week’s syndication”

Royal Bank of Canada

  • RBC sees a 25-basis-point rate increase on Thursday but “follow-on language will matter,” says Vatsala Datta, a rates strategist
  • Gilt move will depend on MPC vote split, she says
    • Assuming it’s a close call and they hike 5-4 in favor, the May Sonia contract will jump by around 22bps straight, according to Datta
    • But then the probability of hikes in future meetings might diminish - and that will really depends on the policy message from BOE
  • “If the May hike does not crystallize, we would argue that there is a good chance that the market reduces the odds of a rate hike to come at all quite a bit,” RBC strategists said in a separate note
    • “The curve is unlikely to steepen much even in that case and we thus consider the downside in flattening trades as rather limited”
  • Conversely, if the hike does materialize, “we think it very unlikely that the market can assign a much higher probability than currently the case that another one will be delivered in November”

©2018 Bloomberg L.P.

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