Mixed BoE Inflation Report Leaves Pound Exchange Rate on Back Foot
Posted by Louisa Heath on May 11th, 2017.
Markets were not impressed by the Bank of England’s (BoE) May policy meeting, leaving the Pound on a downtrend across the board. There had been some hopes that another policymaker might have joined noted hawk Kristin Forbes in voting for an immediate interest rate hike. As a result, when it became clear that the other seven members of the Monetary Policy Committee (MPC) had maintained a neutral outlook, investors were inclined to sell out of Sterling once again.
Following on from a raft of disappointing UK trade and production data this turned so-called ‘Super Thursday’ into something of a damp squib. With confidence in the health of the UK economy dented the Pound was already under downside pressure even before the uninspiring policy meeting. While the accompanying quarterly Inflation Report saw only limited revisions to the BoE’s growth forecasts this was not enough to encourage any uptick in GBP exchange rates.
Discouragingly, the BoE also raised its inflation forecast, predicting that price pressures will rise to 2.7% in the second quarter rather than the 2.4% it estimated in February. Coupled with a warning that wage growth is likely to stall further over the course of the year this did not appear to bode well for the UK economy. As a significant proportion of domestic growth is driven by consumer spending, and with households already showing signs of reining in their finances, the chances of a rebound from 2017’s weak first quarter seemed to diminish.
Another cause for concern was a note in the Inflation Report which stated that:
‘This is conditioned on the assumptions that the adjustment to the United Kingdom’s new relationship with the European Union is smooth, and that Bank Rate follows the market-implied path for interest rates.’
The fact that the BoE has based its forecasts on a softer form of Brexit and transitional trade deal, even though all recent signs point towards a hard divorce, gave investors no real cause for confidence. As relations between UK and EU officials have already soured significantly, before formal talks even begin, the downside risks to these forecasts appear substantial. This left the Pound with little in the way of support, increasing the case for policymakers to maintain a neutral to dovish bias for the foreseeable future.
With Kristin Forbes due to depart the BoE in June the MPC looks set to return to a unanimously neutral outlook. If signs continue to point towards Theresa May pursuing a hard break with the EU or the probability of an exit via the cliff edge is seen to rise then GBP exchange rates could slump even further. In the short term, at least, the mood towards Sterling is expected to remain bearish unless domestic data shows a significant upside surprise.
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