GBPUSD surged on a hawkish hold by BOE but slid after the US NFP

On Thursday, some focus of the market was also on the Bank of England (BOE) after a hawkish hold by the Fed last night and a less dovish hold by the ECB last week. As unanimously expected, the BOE kept all its key policy rates on hold (unchanged) for the 4th consecutive time. The BOE kept unchanged its key/reference policy bank deposit (reverse repo) rate at +5.25% and also lending (repo) rate at +5.50%, keeping borrowing costs at their highest level since 2008 GFC days (16-year).

On Thursday, BOE kept policy rates on hold by 6-3 votes as two policymakers preferred to increase it by +25 bps while one MPC member preferred to reduce it by -25 bps. The BOE said monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term, but dropped a reference to further tightening and acknowledged that the risks to inflation are more balanced.

Still, key indicators of inflation persistence remain elevated although services inflation and wage growth have fallen by somewhat more than expected. Policymakers expect GDP growth to pick up gradually during the forecast period, in large part reflecting a waning drag on the rate of growth from past increases in Bank Rates. CPI inflation is projected to fall temporarily to the 2% target in Q2CY24 before increasing again in Q3 and Q4.

BOE REPO/LENDING RATE

Highlights of BOE’s statement: 1st Feb’24

·         BoE Bank Rate Actual 5.25% (Forecast 5.25%, Previous 5.25%)

·         BoE forecast shows CPI in two years at 2.3% (Nov forecast: 1.9%), based on market interest rates

·         BoE forecast shows CPI in one year at 2.8% (November forecast: 3.1%), based on market interest rates and modal forecast

·         BoE: Market rates imply more BoE loosening than November, show bank rate at 4.2% in Q4 2024, 3.4% in Q4 2025, 3.2% in Q4 2026 (Nov assumption: 5.1% in Q4 2024, 4.5% in Q4 2025, 4.2% in Q4 2026)

·         BoE MPC Vote Unchanged Actual 6 (Forecast 8, Previous 6)

·         BoE MPC Vote Cut Actual 1 (Forecast 0, Previous 0)

·         BoE MPC Vote Hike Actual 2 (Forecast 1, Previous 3)

·         BoE forecasts unemployment rate in Q4 2024 4.6% (November: 4.7%); Q4 2025 4.9% (November: 5.0%); Q4 2026 5.0% (November: 5.1%)

·         BoE no longer says "Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures"

·         We have judged since last autumn that monetary policy needs to be restrictive for an extended period

·         BoE estimates November fiscal measures add 0.2% to real GDP in 2024/25 and 2025/26, and 0.3% in 2026/27; the impact on inflation is less

·         BoE forecasts GDP in 2024 +0.25% (November: 0%), 2025 +0.75% (November: +0.25%), and 2026 +1% (November: 0.75%), based on market rates

·         BoE Gov. Bailey: We need more evidence that CPI will fall to 2% and stay there before cutting rates

·         BoE estimates January services CPI to rise to 6.6% before falling towards 5% in Q2 2024

·         BoE estimates wage growth +4% y/y in Q4 2024 (November: +4.25%), Q4 2025 +2.75% (November: +2.75%); Q4 2026 1.75% (November: +2%)

·         BoE agents’ survey of businesses suggests average pay settlements to fall to 5.4% in 2024 from around 6% in 2023

·         BoE forecasts food prices will be broadly flat, new post-Brexit border checks expected to have only a small impact on food price inflation

·         The medium-term equilibrium level of unemployment is around 4.5%, long-term rate remains just above 4%

·         Potential supply growth is seen at 1.25% a year by 2025 and 2026, up slightly from the November estimate

·         We see zero excess demand in the UK economy, down from a peak of 1.75% at the start of 2022

·         BoE policymakers Haskel and Mann voted to raise rates by 0.25 percentage points

·         CPI is expected to rise back above the 2% target in Q3 2024, not at the target again until Q4 2026, based on market rate expectations

·         BoE sees CPI returning to the 2% target in Q2 2024 (November forecast: Q4 2025), based on market interest rates and modal forecast

·         The MPC will keep under review how long the bank rate should be maintained at its current level

·         BoE sees upward risks to CPI from geopolitical factors including Red Sea, domestic price and wage risks now more evenly balanced

·         The MPC will ensure that the bank rate is restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term

·         BoE forecasts real post-tax household income in 2024 +0.5% (Nov: +0.25%), 2025 +0.25% (Nov: +0.25%), 2026 0% (Nov: +0.5%)

·         The medium-term equilibrium level of unemployment is around 4.5%, long-term rate remains just above 4%

·         Potential supply growth is seen at 1.25% a year by 2025 and 2026, up slightly from the November estimate

·         BoE agents' survey of businesses suggests average pay settlements to fall to 5.4% in 2024 from around 6% in 2023

Full text of BOE’s statement: 21st September 2023- Bank rate maintained at 5.25%

Monetary Policy Summary

“The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 31 January 2024, the MPC voted by a majority of 6–3 to maintain Bank Rate at 5.25%. Two members preferred to increase Bank Rate by 0.25 percentage points, to 5.5%. One member preferred to reduce Bank Rate by 0.25 percentage points, to 5%.

The Committee’s updated projections for activity and inflation are set out in the accompanying February Monetary Policy Report. These are conditioned on a market-implied path for Bank Rate that declines from 5¼% to around 3¼% by the end of the forecast period, almost 1 percentage point lower on average than in the November Report.

Since the MPC’s previous meeting, global GDP growth has remained subdued, although activity continues to be stronger in the United States. Inflationary pressures are abating across the euro area and the United States. Wholesale energy prices have fallen significantly. Material risks remain from developments in the Middle East and from disruption to shipping through the Red Sea.

Following recent weakness, GDP growth is expected to pick up gradually during the forecast period, in large part reflecting a waning drag on the rate of growth from past increases in Bank rates. Business surveys are consistent with an improving outlook for activity in the near term.

The labour market has continued to ease but remains tight by historical standards. In the February Report projections, the continuing relative weakness of demand, despite subdued supply growth by historical standards, leads to a margin of economic slack emerging during the first half of the forecast period. Unemployment is expected to rise somewhat further.

Twelve-month CPI inflation fell to 4.0% in December 2023, below expectations in the November Report. This downside news has been broad-based, reflecting lower fuel, core goods, and services price inflation. Although still elevated, wage growth has eased across several measures and is projected to decline further in the coming quarters.

CPI inflation is projected to fall temporarily to the 2% target in 2024 Q2 before increasing again in Q3 and Q4. This profile of inflation over the second half of the year is accounted for by developments in the direct energy price contribution to 12-month inflation, which becomes less negative.

In the MPC’s latest most likely, or modal, projection conditioned on the lower market-implied path for Bank Rate, CPI inflation is around 2¾% by the end of this year. It then remains above target over nearly all of the remainder of the forecast period. This reflects the persistence of domestic inflationary pressures, despite an increasing degree of slack in the economy. CPI inflation is projected to be 2.3% in two years and 1.9% in three years.

The Committee judges that the risks around its modal CPI inflation projection are skewed to the upside over the first half of the forecast period, stemming from geopolitical factors. It now judges that the risks from domestic price and wage pressures are more evenly balanced, meaning that, unlike in previous forecasts, there is no difference between the MPC’s modal and mean projections at the two and three-year horizons.

Conditioned on the alternative assumption of constant interest rates at 5.25%, the path for CPI inflation is significantly lower than in the Committee’s modal projection conditioned on the declining path of market rates, falling below the 2% target from 2025 Q4 onwards.

The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognizes that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. Monetary policy will ensure that CPI inflation returns to the 2% target sustainably in the medium term.

At this meeting, the Committee voted to maintain Bank Rate at 5.25%. Headline CPI inflation has fallen back relatively sharply. The restrictive stance of monetary policy is weighing on activity in the real economy and is leading to a looser labor market. In the Committee’s February forecast, the risks to inflation are more balanced. Although services price inflation and wage growth have fallen by somewhat more than expected, key indicators of inflation persistence remain elevated.

As a result, monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term in line with the MPC’s remit. The Committee has judged since last autumn that monetary policy needs to be restrictive for an extended period until the risk of inflation becoming embedded above the 2% target dissipates.

The MPC remains prepared to adjust monetary policy as warranted by economic data to return inflation to the 2% target sustainably. It will therefore continue to monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole, including a range of measures of the underlying tightness of labour market conditions, wage growth, and services price inflation. On that basis, the Committee will keep under review for how long Bank Rate should be maintained at its current level.”

Highlights of BOE Governor Chair Bailey’s Comments post MPC meeting: 1st Feb’24

·         There has been good news on inflation in the past few months

·         Evidence is needed before we can lower rates

·         We are not yet at a point where we can lower rates

·         We have to be more confident inflation is falling

·         The level of bank rate remains appropriate

·         We expect CPI to fall in the coming months

·         CPI may tick up in January due to base effects

·         I see CPI around 3% in March.

·         Falling oil and gas prices are reducing UK inflation

·         It is not as simple as inflation returning to target in the spring and the job done

·         Services price pressures remain persistent

·         Inflation is above target for longer than in November

·         Conditions attached to the CPI outlook are important

·         We need to keep policy sufficiently restrictive for sufficiently long, nothing more, nothing less

·         The length of restrictive policy depends on incoming data

·         The continuation of trade disruptions (Red Sea tensions) is an upside risk to inflation projection

·         About two-thirds of the peak impact from higher rates on the economy has now come through, up from about half in November

·         Supply is likely to outpace demand over forecast

·         Questions over official labor market data are posing challenges

·         I see unemployment rising to 5%, above the natural rate

·         Pay growth is slightly weaker than the November projection

·         This year's questions for MPC likely is: "For how long should we keep the bank rate at its current level?"

·         And also "Have inflationary pressures eased enough that we can begin to lower bank rates or not?

·         We have come a long way, that is good news, but we are not there yet

·         We removed the language that had upside bias on the rates outlook

·         We won't speculate on how long rates stick at 5.25%

·         We will not speculate on what we will do at the next meeting

·         I hope that lower inflation will influence expectations in the real economy, but need to see evidence

·         Inflation moving back to around 2.7% is not an acceptable state of affairs, as a resting point

·         We will not maintain the policy stance any longer than we need to do

·         We need to see evidence of services inflation easing back

·         We don't need to see inflation back at target to cut rates, we need evidence that it is heading there

·         Unbacked crypto is not money

·         About 30% of rate hikes are yet to impact the UK economy

·         We could cut interest rates and the policy would still be restrictive

·         BoE's Ramsden: Services inflation is to remain stickier

·         BoE's Ramsden: We're still seeing persistence in services inflation

·         BoE's Ramsden: UK services inflation is higher than in the US and Eurozone

On Friday, BOE’s Pill said:

·         UK GDP prospects are a little better next year

·         UK inflation drop is good news for the economy

·         MPC is focusing on underlying (core) inflation

·         We need to look through the temporary CPI drop to 2%

·         The need for restrictive policy does not mean rates need to stay at the current level indefinitely

·         Different votes on MPC are symptomatic of healthy discussion

·         The time when rate cuts will be possible is some way off for me to ensure inflation is falling

·         We would have to respond to the energy price jump

·         Guidance on rates is conditional on a CPI drop

·         Restrictive rates until inflation is squeezed out

·         The time when rate cuts will be possible is some way off for me

Conclusion:

On Thursday, BOE Governor Bailey sounded less dovish or hawkish like his close friend Powell barely 18 years ago on the other side of the Atlantic; Bailey and Powell both sounded almost similar (hawkish) and both poured cold water of early and deeper rate hikes. The market is now discounting six Fed rate cuts from May (total -150 bps), and five rate cuts by BOE (total -125 bps); but both Fed, BOE and ECB may only cut rates in H2CY24 in a synchronized manner and that too by 75-100 bps.

Before pausing rate hikes since Sep’23, BOE hiked rates by an unprecedented +515 bps (14 times since Dec’21) to keep surging core inflation under control, almost hitting +7% at one point in time. In December, U.K. core CPI was +5.1%, while the 6M rolling average of core inflation was around +5.50%, the highest in G7/G4 as the U.K. may be the biggest loser of the Russia-Ukraine war; both fuel and food cost jumped. Although the U.K. is less dependent on Russian energy/natural gas than the EU, headline inflation (CPI) topped at +11.1% in Oct’22 and was almost halved to +6.7% in Aug’23, now around +4.00% in Dec’23, mainly due to base effect; average sequential rate still around +0.5%; i.e. annualized +6.0%.

Overall, like the EU, the U.K. economy is also under stagflation. And like all the other major G4 central banks (Fed, ECB, BOC), BOE was also swimming far behind the inflation wave/curve (right from transitory to Covidflation and Putinflation narrative). The U.K. has average core inflation of around 6.4% for 2022 and 6.2% also in 2023.

As per Taylor’s rule, for the U.K.:

Recommended policy repo rate (I)= A+B+(C+D)*(E-B) =0.00+2+ (0-0.50)*(6.2-2) =0+2-0.50+4.20=5.70%

Here for BOE/U.K.:

A=desired real interest rate=0.00; B= inflation target =2; C= permissible factor from deviation of inflation target=0; D= permissible factor from/projected deviation of output target from potential=-0.50; E= average core CPI=6.20% (for 2023)

The U.K. should have at least a +5.75% repo rate (considering the potential output gap -0.50%) as a restrictive zone to bring down core CPI back towards the +2.00% target by 2025-26 without causing an outright recession and a surge in unemployment (hard landing). Presently, the repo rate of the U.K. is +5.50%; may be at the lower end of the required restrictive zone (5.50-6.00%), even after considering the likely output gap from potential around -0.50%.

In the U.K., the Government is also ‘helping’ a vulnerable section of society by providing energy and mortgage subsidies (to encounter the burden of higher energy/borrowing costs/EMI). The Government is also borrowing less and not ready to go for any tax cuts to control core inflationary pressure. The Government is also taking various supply-side reforms/measures to increase the overall productivity of the economy along with private business capex to increase the supply capacity of the economy so that it could match with the elevated demand side and gradually bring inflation down to target/normal (along with BOE effort to curtail elevated demand through tighter financial conditions).

But overall, going by the present trend, elevated & sticky core service inflation, it may take another 24 months for the U.K. Core inflation, which was now at +6.2% to fall around +2.00% targets on a sustainable basis. In any way, BOE has to keep the interest rate (repo rate) at real positive levels with at least core CPI (restrictive zone) for at least H1CY24 or full 2024 to bring price stability of 2% in 2025-26. The same is also true for the ECB and Fed.

Now all major G4 central banks; i.e. Fed, ECB, BOE, and BOC are expected to continue on a hawkish hold position in 2024, till at least H1CY24 and if core inflation comes down as expected by then, we may see some rate cuts (75-100 bps) from July’24 by all of them and effectively by all other major G20 central banks. However, all have to maintain a real positive rate of around +0.50% in 2024-25 from the actual core CPI (at least 6M average) to bring a price stability target.

Bottom Line:

BOE may cut rates from Aug’24; i.e. in H2CY24 for a cumulative 75-100 bps in line with Fed and ECB as all has to maintain present policy/rate differential with ‘King’ USD for managing imported inflation and export, everything being equal, whatever may be the narrative.

Technical trading levels: GBPUSD

Whatever the narrative, technically GBPUSD (1.26500) now has to sustain above 1.26000 for any recovery to 1.28000 levels; otherwise sustaining below 1.25600, it may further fall to 1.24800/500 and even 1.21200 in the coming days.