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Bank Of England Preview: One-And-Done Or More To Come

Submitted by Shant Movsesian and Rajan Dhall MSTA from fxdaily.co.uk

Onto one of the main events this week, after the FOMC passed without a flutter and the BoE meet Thursday morning to deliver what many anticipate will be a 25bp hike to reverse the emergency move last summer.  As such, many are pondering whether this intended move - signalled pretty insistently in the prior 2 meetings - is a mere readjustment of the knee-jerk move last summer or whether this is the start of a tightening cycle. 

Based on the data, one could argue that the numbers have been relatively healthy given the level of uncertainty emanating from the Brexit vote.  That said, the data was also on a stronger footing last year before the MPC cut rates, so on the basis of a 25bp cut, one could also argue that 'the accommodation' has not helped in any material way.  With that and the somewhat erratic messages Theresa May conveyed in her interviews outlining her approach to the EU negotiations last year, we saw another sharp tumble in the Pound, and this is where the problems for the BoE really started, fuelling inflation based on the mathematical impact on import prices.   So the BoE made a rod for their own back, and it would not to wrong to assume that they perhaps regret the impromptu rate cut, when many others advised on holding back some ammunition at the time. 

Looking on to the rest of the major economies, Gov Carney at least feels comfortable in absorbing a rate hike in the current climate when the US, and since then Canada are tightening monetary conditions.  As we have seen in the US though, it has been a slow and tortuous process, while in Canada, the 50bp reversal has only served to shoot the CAD higher again, only to fall and give back all of its interest rate induced gains as momentum in the data fades.  While North America renegotiates NAFTA, the Brexit process will be infinitely harder to quantify in terms of risk, and as constructive as minister David Davis believes the talks have been, the EU reminds him and the PM that progress is far from satisfactory. 

Of the greater concern in hiking rates at this time is household debt. As disposable income and indeed real income, recede, the MPC must surely take account of how the economy will take to a rate move at the present time.  Earlier this week we saw personal credit rising again, so indebtedness is a worry to consider despite the relaxed tone from certain quarters at 'the bank'.  Over the summer we saw a strong set of retail sales numbers which have since turned a little sour, highlighting the impact of tourist season and at a time when the Pound is/was cheap.  UK growth depends on the high street for input, and if households are squeezed further, then the consumer will be adding little to headline GDP. 

The financial services sector is the big revenue earner for the Treasury, but this week's case studies on the potential job losses and business put another dent into prospective growth, but this is and has been a major concern for some time, though the BoE seem confident that business investment is holding up and London relocations will be moderate.  Once again, uncertainty reigns, but we are told rates are too low.  If rates do rise tomorrow as they are largely expected to, we should see a sharp GBP response, but also very likely short lived.  Central banks have the power of forward guidance at the present time, and the BoE have convinced many people that this is the start of a tightening cycle.  10yr Gilts are sticking close to 1.40%, but as we have seen with the Fed and the BoC, things can change quickly.  Whether it is conveyed tomorrow or not, we see a much higher probability of this being a 'one and done' - there are just too many unknowns otherwise.   Once the currency effect passes through inflation, the MPC will have an easier decision to make - eventually - but hopefully not before it is too late! 

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And here are some additional thoughts from Bloomberg macro commentator Tanvir Sundhu

BOE Won’t Easily Give Up Its Hard-Won Optionality: Macro View

The BOE meeting may not prove kind to traders positioning for a one-and-done interest rate hike.
The central bank needs to maintain its hard-won control in the rates market. After the BOE expressed a greater urgency for a rise at its last meeting, the central bank’s credibility will take a hit if it fails to hike.

The market prices a more than 90% probability of a 25 basis-point increase today, with a subsequent hike seen in September 2018 and three in total by 2020. Prior to the June meeting, no rate moves were priced until 2020. So the BOE’s forward guidance belatedly helped it gain control over the forward curve.

The U.K. swaps curve is suggesting the market views the BOE’s terminal rate at about 1%. That appears low given one of the main justifications for a hike is the persistence of above-target inflation.

Market pricing may be validated if the MPC delivers an increase and offers no new guidance, which may see a relief bull-flattening of the curve (particularly under a 5-4 vote). And a so-called dovish hike may see real yields move lower in the belly of the curve. But the selloff in gilts after September’s meeting showed what a more- hawkish-than-expected outcome can do.

To be sure, there are many factors that define the rate-hike cycle. Unsecured credit conditions have tightened while the MPC’s Term Funding Scheme ends in February, adding uncertainty for the outlook and damping the odds of a second increase in the first quarter.

And with domestic pressures -- wage growth, productivity growth, unit labor cost -- contained and Brexit-related FX-weakness having passed through to prices faster than expected, inflation next year will likely return to target in the first half

Low-delta options on sterling-denominated assets may be attractive given the fragility of Brexit negotiations and the many possible outcomes that exist.

So yes, there are definitely factors that weigh against a more hawkish tilt. But after fighting so hard to buy itself some optionality by making clear that the policy reaction function won’t be restrained by Brexit uncertainty, the BOE isn’t going to give it away for free. "One-and-done" is unlikely to be the trading narrative that comes out of today’s meeting.