- We expect the Bank of England to hike the Bank Rate from 0.50% to 0.75%, as activity indicators have rebounded and the unemployment rate is low.
- We expect the Bank of England to hike once a year.
- We look for EUR/GBP to remain range bound near term, with Brexit uncertainty expected to remain a key source of volatility.
Bank of England outlook: hike but no new signals
As activity indicators have rebounded and the unemployment rate remains below the Bank of England’s 4.25% NAIRU estimate (actually, the single-month unemployment rate is now below 4% on the second decimal place), we believe the Bank of England is set to raise the Bank Rate by 25bp to 0.75% at the upcoming meeting despite inflation being lower than expected.
While we still believe the Bank of England is too optimistic on the inflation outlook, it seems that Mark Carney and company are more concerned about overheating the economy. Despite growth on average being lower now than before the Brexit vote, it is still sufficient to absorb the remaining slack, as potential GDP growth has declined as well. Like many other central banks around the world, the Bank of England believes in the Phillips Curve and thinks underlying inflationary pressure is increasing as the labour market continues to tighten. We expect the Bank of England to hike once next year. With respect to the tone of voice, we do not expect big shifts. In our view, the Bank of England is likely to repeat that ‘ongoing tightening of monetary policy over the forecast period would be appropriate’ but that rate hikes ‘are likely to be at a gradual pace and to a limited extent’.
Remember the Bank of England made a significant change to its QE guidance at its last meeting, as it said it would not consider reducing the stock of purchased bonds until the Bank Rate reaches 1.5% (previously 2.0%). This is a sign that it thinks the natural rate is low and that it does need to raise the Bank Rate many times before monetary policy is neutral.
FX outlook: EUR/GBP range for now but lower eventually
We expect EUR/GBP to trade slightly lower going into the Bank of England meeting. However, given that the market almost fully discounts a rate hike, we expect any rally in the GBP to prove short-lived. The GBP has been one of the weakest performing currencies in the G10 space over the past month, as political uncertainty related to Brexit has outweighed the growing prospect of a rate hike from the Bank of England in August. We could see a bit of a relief from the recent sell-off pressure in GBP from the political side after the UK Prime Minister yesterday relegated the Brexit department. However, overall we look for EUR/GBP to remain range bound near term, with Brexit uncertainty expected to remain a key source of volatility.
Longer term, we still expect EUR/GBP eventually to trade lower driven by Brexit clarifications and fundamental valuations. We target EUR/GBP at 0.8650 in 3M, 0.8400 in 6M and 0.8300 in 12M.
