Sterling risks 82-month lows on dovish Bank of England – Jan 13th 2016


The Bank of England is likely to leave interest rates on hold at Thursday’s meeting potentially on a 9-0 vote with McCafferty dropping calls for a hike while the policy summary is likely to be more downbeat. The dovish tone will be tempered by the impact of low oil prices on spending and recent Sterling weakness on inflation. It is also the case that Sterling selling ahead of the decision will limit the scope for further losses after announcement. Nevertheless, overall sentiment is being undermined on economic and political grounds and Sterling is vulnerable to near seven-year lows below 1.4200 against the dollar before any corrective recovery.

The Bank of England monetary policy decision will be released on Thursday along with the summary and minutes. As ever, markets will need to be on high alert for leaks ahead of the release given that the decision is actually made several days in advance. So far, since the introduction of the new system during 2015, the process has appeared water-tight, but it has not been tested under contentious conditions.

There is a strong probability that interest rates will be left on hold at 0.50% once again, the last change having occurred in March 2009. At December’s meeting, the MPC commented that there had been no significant international developments since November’s inflation report. This month the policy summary is likely to make greater reference to the global economy with downside risks likely to be seen as a greater threat since the last meeting. The sharp drop in oil prices will also be an extremely important element in the discussion. Headline consumer inflation is already close to zero and the drop in energy prices will put further downward pressure on inflation in the short term.

There will be a further discussion of domestic earnings growth and the data released after last month’s MPC meeting was significantly lower than expected. There will be further uncertainty surrounding underlying trends, but the overall expectations will be for weaker earnings growth which will mean that spare capacity in the economy is likely to be used up even more slowly. There will be expectations of slightly lower growth overall and a downward adjustment with overall sentiment likely to be generally downbeat.

There are two factors which could mitigate against a much more pessimistic outlook. Firstly, the drop in oil prices will trigger a further drop in retail energy prices which will have a significant impact in boosting disposable income. The impact will be lessened to some extent by the high level of petrol taxes which lessens the drop in prices. The second factor is that Sterling has weakened sharply against all major currencies over the past month. During the course of 2015, the Bank of England expected that past Sterling appreciation would act as a drag on inflation and delay any potential tightening. Sustained falls in Sterling would certainly reverse this process and, if the more doom-laden predictions for the currency are correct, the MPC could eventually be forced to raise rates to curb Sterling losses. 

There will be speculation that McCafferty abandoned his call for higher rates at this month’s meeting with a 9-0 vote. There is certainly little chance of anyone joining McCafferty in voting for an increase given recent developments and comments. Weale, who is at the hawkish end of the MPC spectrum, commented at the turn of the year that the case for higher interest rates was now less pressing while Forbes, who also has hawkish tendencies commented in December that the current rate of earnings growth was not strong enough to justify higher rates. Events since then have further weakened the case for a rate increase.

Underlying Sterling sentiment will be undermined by the current account deficit near 4% of GDP and increasing political uncertainty ahead of the planned EU referendum which is likely by Autumn 2016.