While potential US-China-EU trade war continues to grab the headlines, central bank policy is driving FX midterm positioning.
Last week, the BoE kept policy rate unchanged as widely expected. However, the surprise came from the voting margin, which shift towards a hike. Chief economist Andy Haldane voted for an interest rate hike moving the vote to 6-3 from 7-2. In a hawkish skew, the MPC clearly view the current soft activity in Q1 was transitional, despite indication that weak manufacturing output is not the result of harsh winter conditions. Insight into members thinking, forced markets to reprice the probability of an August hike from 35% to 56%. This puts the likelihood of interest rate move by November at 70%. However, judging by limited reaction in GBP, markets are not completely convinced.
Last spring the MPC had also voted 6-3 for a hike, yet within two months, the voting had regressed to 9-0 for no tightening. On one hand, with the 2019 Brexit deadline quickly approaching, UK political disorder has a significantly higher cost.
On the other, the BoE statement provide some unexpected comments including news the threshold for normalization has been lower. The accompanying statement read, “MPC now intends not to reduce the stock of purchased assets until Bank Rate reaches around 1.5%, compared to the previous guidance of around 2%."
With our general view, we believe that central bank are shifting toward “normalization” is less a reaction to economic data but rather a desire to secure policy tools. Given this view and the MPC indication that August remains a potential date to hike rates, we believe that the BoE will likely increase rate by 25bp this summer. Sterling traders are under-pricing the risk of near term policy action.
We anticipate GBPUSD to extend bullish rally to 1.3600 in current conditions.
In regards to the ECB, Draghi & Co. was able to sell the markets a dovish message. Markets have been focused on the statement that policy rates will remain stable “at least through the summer of 2019,” notwithstanding Draghi already indicating that this statement had been deliberately ambiguous. Overall, comments from generally quiet ECB policymakers have just further confused investors. But below the bluster seems to be an effort to keep focus on ending asset purchase and away from interest rates. This strartety makes sense given the markets obsession with rate and bullish effect on Euro. As with the Fed, the ECB will need to quietly steer interest rate higher without alerting the FX market.
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