British Pound: Clinging on to a hawkish Bank of England

What makes today’s Bank of England meeting particularly intriguing is that all potential scenarios– from a dovish hold to a 25bp rate hike – are conceivable outcomes. Indeed, this is largely down to what can only be described as sheer confusion over the Bank’s post-Brexit policy reaction function. The sharp swing in policy expectations in response to one set of monthly data releases and off-the-cuff comments by Governor Mark Carney – as well as the wild gyrations in GBP markets in recent weeks – should serve as a warning shot to the MPC over the growing policy uncertainty in markets.

A 25bp rate hike today is not a forgone conclusion – and largely depends on which type of MPC shows up today; a risk-averse approach would be to wait-and-see whether the softer 1Q UK GDP data is in fact transitory, though officials could equally opt to ‘look through’ this and press ahead with a 25bp hike if they remain convinced that their outlook for the jobs market and a fall in inflation will lead to a boost in real household incomes. The risk-averse approach, however, has been the norm in post-crisis monetary policymaking. If this is the case – and we do see the BoE on hold – GBP’s initial reaction will be a function of: (i) the MPC vote split and (ii) the language around the soft 1Q activity data. The combo of a third rate hike dissenter and the post-meeting statement referring to a ‘transitory’ soft patch would lift GBP/USD up to 1.3700 – as odds of an August BoE rate hike rise (currently 50:50). All our GBP scenarios can be found in our preview note GBP & BoE: Carney’s Chameleon Act.

There are early signs that the vicious circle of higher US rates and a strong US dollar, negative emerging market sentiment, sell-off in EM assets and weakness in EM FX (which then loops to fuel a stronger USD) may well be coming to an end. But there are a few lingering negative idiosyncratic stories that may continue to weigh on investor sentiment towards EM assets overall in the coming weeks (the surprise election outcome in Malaysia joins Turkey and Argentina on the monitoring list). US CPI data today could see a further shake-out in risky assets – especially if we see a print stronger than 2.5% year-on-year consensus, which would likely see the US 10-year yield firmly breach the psychological 3% handle. The US dollar index to consolidate around 93.

The ECB is due to release its monthly Economic Bulletin today (1000 CET) – and of particular interest is the central bank’s latest update on the eurozone's inflation prospects following the lower-than-expected April core CPI print (that dipped to 0.7% YoY). ECB watchers will be focusing their attention on commentary around the ‘super core’ inflation estimate – which strips out items in the CPI basket that are most sensitive to changes in the output gap. Chief Economist Peter Praet hinted that soft CPI outturns are transitory – but investors will need to see evidence in data before buying into a higher EUR/USD story. For now, look for stability above 1.18.

As Petr and Peter note in ‘NBH is still the king: Fade the move & receive rates’ – we see the latest rise in Bubor as driven by technical issues and don’t expect it to last. We also get Czech CPI data today; Jakub Seidler is looking for a 1.8% YoY print (also consensus), but doesn’t think a small miss – in particular one caused by volatile food prices – will be a game-changer for our hawkish central bank outlook.