The Bank of England convenes on Thursday in a highly anticipated decision, especially after teasing us 3 weeks ago. Here are three opinions:
BoE Should ‘Kitchen Sink It’; Will GBP Break Below 1.30? – BofA Merrill
The UK soft data looks bad (Chart of the Day): the economy has taken a big hit and may be in contraction. Rate-setters will have to cut their growth forecasts heavily in the 4 August Quarterly Inflation Report and highlight the downside risks, though we do not expect them to forecast recession (just).
The BoE should throw the kitchen sink at the problem: the worst thing that could happen now is the stimulus does not work, so better to do too much. Dismal data since the BoE’s last policy meeting (which rate setters seemed not to expect) and MPC member Martin Weale’s dovish flip-flop suggest less risk of disappointment. If the services PMI is lowered on Wednesday the BoE will be under more pressure to go large. We look for a 25bp rate cut, £50bn QE split between gilts and corporate bonds, and ‘credit easing’.
In rates, a greater chance of QE has been priced in recently. However, 10y spreads suggest to us our base case of £50bn is not yet fully priced. We continue to like 5s20s gilt flatteners.
FX: GBP Implications:
Following the July decision to keep rates on hold, we believe that Bank of England cannot afford to disappoint again as far as FX markets are concerned. However, we doubt a 25bp rate cut would be sufficient for a sustained break below 1.30 in GBP/USD.
Given the recent run of poor data and the decision by MPC member Martin Weale to reassess his view on the UK economy, the market is now fully priced for a rate cut. The extent to which the market is priced for a QE response is harder to calibrate, but we doubt this would come as a total surprise given the terms upon which the Bank of England has spoken about the need to respond to the current period of heightened uncertainty.
Nonetheless, a rate cut accompanied by a QE response would be initially negative for the currency as GBP rejoins the ranks of the funding currencies (JPY and EUR), but without having the luxury of a current account surplus. However, we are cognizant of the recent trend where central banks have delivered further QE, but their currencies have subsequently rallied.
The key to whether GBP weakness can be sustained is the extent to which the Bank of England forecasts leave the door open for a further policy response in the months ahead.
GBP: Risk For Sterling Is Two-Fold But Room For Selling Into And After BoE – Citi
Our economics team is forecasting a 25bp cut in the bank rate and a resumption of QE – forecasting 75bn in purchases over the next 4-months. Forecasts for inflation and growth will be reduced.
The risk to sterling is two-fold:
Given the market expectations have been building for weeks, the bar for the BOE to deliver will be fairly high leaving an upside surprise difficult.
Still, we remain bearish on GBP. A resumption to rate cuts and asset purchases would be a long-run signal for Real Money accounts that have been slow to rebalance their asset holdings.
From that angle, we see room for some GBP selling into and after the event.
GBP: Staying Long; GBP/USD To Bottom Out At 1.29 & EUR/GBP To Top Out At 0.85 – Credit Agricole
The GBP has been broadly range-bound over the last few weeks. This is mainly due to limited room of further rising rate cut expectations. In line with market expectations, we believe that the BoE will lower interest rates by 25bp this week and announce further credit easing measures. However, we believe the central bank will refrain from boosting its gilt purchases.
Overall, we believe that the MPC may struggle to exceed the already dovish market expectations and see scope for further GBP consolidation in the near term.
Longer-term, disappointing data out of the UK, as well as the Balance of Payments adjustment, could keep the risks for the currency on the downside. That said, some negatives are already at the price of GBP and we believe that most of the currency correction is behind us.
We expect GBP/USD to bottom out at close to 1.2900 and EUR/GBP top out at close to 0.8500.
In terms of trade, we stay long GBP/CHF. * The cross may benefit from position squaring and renewed scope of the SNB turning more aggressive later this year.
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