The Bank of England’s next move – too close to call

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Updated: 17 March 2020
  • The Bank of England (BoE) will announce on Thursday if UK interest rates are to be cut.
  • With the current base lending rate at 0.75%, market opinion is split between ‘cut’ and ‘hold.’
  • The Monetary Policy Committee (MPC), which will deliberate on the issue, also has a track record for producing surprises.
  • With markets pricing in a 50-50 chance of lower rates, whichever outcome is confirmed should bring about significant price action.

Some market participants think that Thursday could bring about the first cut to the UK interest rates since 2016, while others say that it is too close to call. Earlier in January, the likelihood of a rate cut was widely considered to be approximately 70%, but the odds have widened, with the chance of a cut is currently put at 50%.

The two schools of thought are referring to different data sets, which analysts say offer contradicting signals. Further confusion is caused by the blockages in the economy caused by Brexit and the general election of December, which make data harder to interpret. There is also the matter of a new governor of the BoE taking up the post in the coming weeks. Will incumbent governor Mark Carney encourage his colleagues to vote for a cut or hold them at 0.75% and allow the incoming governor Andrew Bailey to stamp his own authority on the markets? Considering the likely outcome, Robert Wood, chief UK economist at Bank of America, said:

“We had thought that the MPC might wait until a few months after the general election, or the chancellor's first Budget, to make a decision on interest rates… But it seems as though they might want to offer a helping hand to the economy a bit sooner than expected.”

Source: BBC

 

Same again

Putting the rate-cut question into a historical context shows that the BoE’s recent track record has been to cut first and ask questions later. In the aftermath of the surprise referendum result of June 2016, the BoE cut rates for the first time in seven years. Not only were rates cut, but growth forecasts were also revised downwards as the BoE joined or even encouraged the sense of alarm. Base-rate lending costs were slashed from 0.5% to 0.25% and GDP growth forecasts for 2017 were downgraded from 2.3% to 0.8%. The actual return for the year turned out to be 1.8%, much closer to the original estimate.

UK GDP Annual Growth Rate 2010-2020

Source: Trading Economics

There has subsequently been some criticism of the BoE and Governor Mark Carney. As the doomsday scenario failed to materialise and the economy stabilised, it looked like the actions of the BoE had been counterproductive. Carney might claim that it was the BoE’s actions that saved the situation, but rule number one for central bankers is to instil confidence in the financial system. Given that the cut was soon followed by rate hikes, there is plenty of room to consider the 2016 cut a rash decision.

UK Interest Rates – 2010-2010

Source: Trading Economics

Referring back to the events of 2016 confirms that Carney is, or at least was, aware of the benefits of keeping rates away from zero. Carney told CNBC at a 2016 press conference:

“I cannot see any scenario where I would consider negative interest rates.”

Source: CNBC

Strange things happen when rates near or breach zero. Holders of positive cash balances in the eurozone are in this situation and have had to get used to the idea of paying a central bank to hold cash balances. In a similar way, German government bonds pay negative yields, so investors who buy them are paying the German government for the privilege of lending to the Berlin government. The peculiarities of the situation also mask a more important feature of low-rate economics, whereby monetary policy tools become less effective when close to zero. In such a circumstance, the marginal return from a rate level change diminishes.

Germany’s Government Bond Yield Curve as of October 2019

Source: Reuters

 

Cable

Forex traders, particularly those with interest in GBPUSD, have an opportunity to profit from making the right call. Midway through the European session, GBPUSD is holding at levels around 1.30. Given the uncertainty over the BoE’s decision and indeed the US Federal Reserve’s own rate announcement due on Wednesday, the market is trading sideways on a ‘big number.’

GBPUSD – Intraday chart – 29th January 2020

Source: TradingView

Daily technical levels from FXStreet show the 20-day SMA at 1.3078 and the 50-day SMA at 1.306, meaning that price is held in the zone between the psychologically important support of 1.30 and two key indicators.

Source: FXStreet

The next leg of a directional move could soon be triggered. A rate cut could then build downward momentum due to other underlying factors that look ready to weigh on sterling. Analysts at TD Securities offered a range of factors that might come into play before the end of the week.

“GBP seems likely to remain more sensitive to virus-driven sentiment fluctuations and ongoing Brexit considerations than BoE policy for now. Our base case suggests some moderate downside GBP risks. That said, the spot may rally sharply on a hawkish surprise if future rate cuts are priced out with confidence.”

Source: FXStreet

Short-term and long-term trading opportunities seem about to materialise. The unnamed media source who was caught giving certain traders an early ‘heads up’ on the MPC’s decision will note that the January announcement due on Thursday is one where high-frequency traders could make handsome returns. Through 2019, the audio recordings that were leaked to hedge funds provided early confirmation of foregone conclusions that left little room for whip-sawing prices. The reaction to the news on Thursday will be very different. The BoE’s decision is likely to disappoint half of the market but delight the other.