The Bank of England has hiked once more, for the 14th meeting in a row. However, just as other major central banks (such as the Fed and the ECB) have done recently, there was more of a dovish tilt to the decision this time. A 25 basis points hike to 5.25% is leaving GBP traders feeling that the days of consistent outperformance may be set for a retracement.
- A 25bps hike, restrictive policy and data dependence
- Market positioning suggests that the end of tightening is close
- GBP is under selling pressure versus USD and EUR
A 25bps hike, restrictive policy and data dependence
After hiking aggressively by 50 basis points (bps) in June, the Bank of England (BoE) has opted for a calmer 25bps in the August meeting of the Monetary Policy Committee (MPC). There are also some suggestions that the end of the tightening cycle may not be too far off. This looks to have been a dovish hike.
A 25bps hike was broadly as the market consensus had been expecting. The voting on the MPC was also broadly reflecting a market that had been priced for around a 33% probability of a 50bps hike. Two on the MPC voted for a 50bps hike, whilst six voted for 25bps and just one for keeping rates steady.
Inflation is still clearly an issue that the BoE needs to tackle. After all, headline inflation of 7.9% is still way higher than the 2% target. The BoE is still putting out signals to suggest that policy will remain tighter for longer, noting that the stance will remain :
“the MPC would ensure that Bank Rate was sufficiently restrictive for sufficiently long to return inflation to the 2% target”
So we should not be anticipating any rate cuts to be coming any time soon. However, notably, the minutes of the meeting said that “the current monetary policy stance was restrictive”. With policy already restrictive there will be some caution that begins to creep in now, especially as the BoE’s data shows activity indicators have deteriorated since May. The pace of the path lower that inflation takes over the coming weeks will be key. They see inflation down to 5% by the year-end, which would be below the Base Rate.
The BoE has also said that it is now “evidence driven” with special attention being given to the labour market and wage growth. The BoE is data-dependent, just like the Fed and the ECB.
Markets are reining in rate hike expectations
Crucially, markets are viewing this as a dovish hike from the BoE. Looking at the UK 2-year swaps (which give a strong indication of interest rates) we can see the SONIA rate has fallen below 5.50% today. According to Bloomberg, the peak rate for the BoE is also now below 5.75% by February.
With the Base Rate now 5.25%, this suggests that whilst a 25bps hike is still highly likely in September, beyond that, the outlook begins to look more hazy. If inflation continues to come down (especially if services inflation turns decisively lower) then the BoE may see the restrictive policy already in place and believe that rates have gone high enough.
GBP is suffering as the outperformance reverses
With the yield on the 2-year Gilt falling between -5bps to -10bps this is weighing on GBP with decisive moves on both GBP/USD and EUR/GBP.
From a technical analysis basis, the move lower on GBP/USD is signalling a potentially decisive shift in the outlook. An uptrend since October that has been consistently pulling Cable higher has now been broken. A new near-term downtrend is growing and if this continues could become a dominant force in the outlook.
I will be watching two key factors that would tell me that the outperformance of GBP is reversing. Firstly the key support of the higher low at 1.2590. If this is breached on a closing basis, with this new downtrend formation, it would be a significant change to a corrective phase. Secondly, if the daily RSI confirmed the breakdown with a move below 35. The daily RSI has not been below 25 since the recovery began almost 11 months ago.
There is also an important move developing on EUR/GBP. I discussed a potential rally in EUR/GBP as the EUR was starting to build support. This move has been exacerbated by the GBP weakness we are seeing today.
EUR/GBP is rallying away from the support between 0.8500/0.8570 and now looks set for a recovery towards a test of the resistance band between 0.8701/0.8734. Momentum is improving in this move and a rally towards what has been the top of a six-month downtrend channel is developing again. Reaction to that resistance will determine whether the retreat of GBP gathers pace against the EUR too.
