GBP: The ‘Carney Put’
Despite a tricky month of politics for GBP, speculation of a Bank of England rate hike has provided a backstop to the currency sliding lower. As long as the 'Carney put' stays in place, we remain constructive on GBP heading into year-end and look for GBP/USD at 1.35-1.36 on a steeper UK rate curve.
BoE rate hike talk has been a backstop to GBP sliding lower
- It would be a major surprise if the Bank of England (BoE) did not hike this week given their recent signals. We expect to see the 'Carney put' in full force for GBP, with the BoE hiking by 25bp and keeping the currency supported. Indeed, amid the heightened political uncertainty, speculation of a BoE rate hike has provided a backstop to GBP falling meaningfully. In the absence of this 'Carney put', GBP would have conceivably been trading much lower than it currently is.
- If there's one central bank not concerned about the macro effects of a stronger currency it’s the BoE. Sure the activity data has been a bit mixed of late (understandable given the economic uncertainty), but it’s becoming clear that the Bank wants to prevent the emergence of a genuine stagflationary environment. A couple of rate hikes may not derail UK economic growth, but could certainly keep price pressures in check – especially when currency dynamics have been playing a stronger inflationary role. Some BoE officials may also see the effects of GBP's post-Brexit depreciation as being less transitory – and more persistent – than originally thought. Be it directly or indirectly, a weak GBP is playing a more prominent role in the BoE’s policy thinking.
'Gradual tightening' signal gives the BoE policy flexibility
- With a rate hike all but priced in, what matters this week is the type of tightening cycle the Bank signals. Markets have got a bit of cold feet in recent weeks, so the follow through of a 25bp rate hike should be mildly GBP supportive.
- But what could really drive GBP higher is if the Bank signals that this is more than just a 'one-and-done' move and instead the start of a gradual tightening cycle. Gradual is a pretty fluid concept – and while the next rate hike will inevitably be data-dependent, this laissez-faire forward guidance won't stop markets from bringing forward their expectations for additional BoE rate hikes.
- Assuming we get a 25bp rate hike this week, we would only expect GBP to move lower if there were (a) more than two dissenters or (b) an explicit statement ruling out another rate hike in the near-term – both of which would see the UK rate curve flatten as markets price out additional BoE tightening. The latter option seems highly unlikely – and somewhat inconsistent with typical central bank forward guidance that aims to retain an element of policy flexibility.
- Moreover, for the idea of the 'Carney put' to work – and the pound to remain supported – the BoE will need to at least give off the illusion that additional rate hikes are warranted. This can be wrapped with the usual data- and Brexit-dependent caveats, but shouldn't necessarily see markets price out further tightening following this week's meeting.
| 1.35 |
GBP/USD year-end target under a steeper UK rate curve |
GBP/USD reaction under various Nov BoE meeting scenarios
Bottom line
We look for GBP/USD at 1.35-1.36 over the next month as the front-end of the UK rate curve steepens, while speculation of additional BoE rate hikes should prevent any meaningful move below 1.30. For EUR/GBP, we remain comfortable with the 0.88-0.90 trading range for now. We're not exactly shooting for the stars because we're aware of the Brexit-related risks stemming from the December EU summit – which could be a make-or-break moment for GBP.
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