- BoE remains on hold with downside risks to the inflation outlook…
- …pushing sterling lower
- We expect the first rate hike in August next year
- US dollar remains strong ahead of the US employment report
Bank of England remains on hold with downside risks to inflation outlook
Overnight, the Bank of England (BoE) left monetary policy unchanged as widely expected. It voted by 8-1 to maintain Base Rate at 0.5%. The dissenter was Ian McCafferty who preferred to increase the Bank Rate by 25bp. The BoE expects that CPI will remain below 1% until the second half of next year. Beyond that, the dampening influence of sterling’s past appreciation on inflation is expected to be persistent. In this context, the MPC judged it appropriate to return inflation to the target in around two years. The MPC also sees downside risks to CPI over the next 2 years. In addition, it trimmed its growth forecast. The more dovish than expected MPC led to a downward adjustment of rate hike expectations for next year. Financial markets are currently pricing in a 35% probability of a 25bp rate hike in the last four months of 2016. Expectations for a total of 50bp in 2016 have been reduced.
UK economy is growing at decent pace but inflation is subdued
The UK had the strongest economic growth of G7 in 2014. Since then economic growth has cooled but is still decent. Manufacturing and construction are the weak spots, while the UK consumer has remained in good shape. The UK unemployment rate is low and continues to fall and wages have started to move higher. We expect the BoE to be cautious in raising interest rates because inflation is subdued. We have pencilled in our first 25bp rate hike in August 2016. As we expect the BoE to start hiking interest rates after the Fed, we foresee a weaker GBP/USD in 2016 up to the moment financial market start to price in a rate hike for the BoE. However, we expect sterling to outperform the euro next year because of the monetary policy divergence between the UK and the eurozone.
US dollar remains strong ahead of US employment report
The US dollar (USD) strengthened against most major currencies and precious metals because of expectations that the Fed could hike interest rates in December. This was because US economic data surprised on the upside and Fed members made hawkish comments. Financial markets have priced in around 60% probability of a Fed rate hike in December. Our base case is a hike will be delayed to 2016, but chances of an earlier move have risen. Our year-end forecasts for 2015 and 2016 for EUR/USD are 1.10 and 1.00, respectively, reflecting the start of the hiking cycle next year. If US employment report surprises on the upside today, the upward momentum in the US dollar will become stronger.