"Painting Yourself into a Corner" revisited ....

"Painting Yourself into a Corner" Revisited .... the Bank of England has nowhere else to go, right ?

ref :- "Focus turns to strength of BoE's resolve" , The Financial Times, Markets and Investing

Tomorrow the Monetary Policy Committee (MPC) of the Bank of England will deliver its decision on whether to lift rates for the first time in over ten years. After all the heavy signalling from Governor Mark Carney and others in recent weeks, you'd think that a 1/4 point hike was absolutely guaranteed ..... positively nailed on. There remains a scintilla of doubt though ..... partly a result of Mr Carney's unfortunate but probably justified reputation for suggesting courses of action that don't always come to pass, and partly because among those who don't believe that a rate rise is such a good idea (and there are plenty), there are still just a few who believe that the MPC will do what they consider to be "the right thing" even if it further compromises the Bank's credibility. Frankly, we doubt it but can see their point.

Markets are rating the probability of a hike tomorrow at about 90%, which is a fairly convincing pointer. If by some chance the BoE was to stand pat, you could expect the damage to the value Sterling to be almost as heavy as the damage to the standing of the Old Lady of Threadneedle St. It's anyone's guess of course but people are talking of GBP / USD , currently pretty buoyant at just above $1.33, dropping pretty immediately back down to $1.27. That's the kind of thing that happens when you build up expectations only to dash them.

*** NOTE : Just 8 out of 59 institutions surveyed by Bloomberg expect a "no change" decision, though they do include some influential ones ***

Along with the majority we're going to assume that we'll see an increase in the base rate from 0.25% to 0.5%. The question then is whether it is a so-called "soft" hike, or the start of a tightening cycle on the road to (comparative) rate normalisation -- and to get the answer to that we'll have to see how the 9 members of the MPC vote, and listen to the accompanying statement from Mr Carney.

Just because it's unlikely to happen doesn't mean that there aren't legitimate arguments for the Bank to surprise the markets by doing nothing tomorrow. In contrast to those of both the United States and mainland Europe, the UK economy is stuttering along with confidence and investment under the cosh as the difficulties that were always likely to be part of Brexit become more obvious. We can expect plenty more of it too, and generally speaking the last thing one would impose on a limping economy is higher rates ..... unless possibly you're facing the prospect of rampant inflation. As we said the other day, many would argue that a short-term spike in inflation provoked by currency weakness rather than excessive domestic wage rises and consumer spending say, does not qualify as the kind of inflationary concern to merit rate hikes when other data is weak.

It's also probably true that any major concessions made by the UK in an attempt to secure a "soft" Brexit will provoke possibly terminal conflict between those prepared to compromise and ardent Brexiteers within the ruling Conservative party. A change of government right now would really frighten the markets, and about the best you can say is that the light of the end of the Brexit tunnel, and therefore an upsurge of confidence in the economy, is still a long way off.

The point is that if any of the MPC members are thinking that way and dissent from a decision to lift rates, if the vote to do so was 6 - 3 or even 5 - 4 for example, you'd have to think that a hike tomorrow would definitely NOT point to more rises in the pipeline. It would be a case of "One and Done", as they say. On balance, with the inflation factor expected to weaken anyway, "One and Done" probably the most likely scenario. What might that mean for markets ?

In the great tradition of "Buy the Rumour, Sell the Fact" , you could make a strong case for Sterling to fall after a "soft" hike. The markets have been "buying the rumour" (or the expectation) , and if there are no indications of further rises to come it must be reasonable to expect those short-term traders to sell their long-Sterling positions once the hike is out of the way. A move down to $1.30 is being suggested, along with a rally in interest rate instruments such as Gilts (which of course means a fall in their yields).

It's just possible that Mr Carney might communicate that a hike tomorrow might be the start of some kind of tightening circle ..... well, you can't discount the possibility even if it's not the majority view. If that scenario should come to pass, you could expect more buying of Sterling with a test of the recent highs above $1.35 a reasonable target. You should also see a fall in the price of shorter maturity Gilts most affected by moves in the base rate (and a rise in their yields), but the reaction in the longer end of the Gilt market may not be so marked. The longer end is unlikely to be able to dismiss the concerns over growth posed by Brexit, and in any case is supported by natural demand from pension funds and other institutions to a degree larger than many other sovereign debt markets.

As the FT points out, that at least would be of some cheer to UK Chancellor of the Exchequer Philip Hammond. As he loosens the stays on the austerity corset and increases issuance of longer maturity Gilts, anything that keeps borrowing costs down has got to be welcomed.

Over to you, Mr Carney.

P.S. Don't forget that the US Federal Reserve are making their rate decision later today -- expect "No Change", and the way to be cleared for a hike next month (not that it needs much clearing). Of more interest is President Trump's nomination for the next Chairman of the Fed, now expected tomorrow. Jay Powell is the talking horse and now a clear favourite -- if such a thing exists when one's trying to read Mr Trump's mind. Mr Powell would be the continuation candidate (if you exclude Janet Yellen, of course), with a marginally easier position towards regulation of financial markets. If John Taylor got the nod, his hawkish reputation would likely prompt Dollar buying and a sell-off in Treasuries. As for the others, word has it that their race is run .... but of course, you never know.

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