Policy Divergence Growing

Over recent months the Bank of England has started to display clear divergence among its members in relation to its monetary policy approach. Last week, renowned dove Andy Haldane suggested that a rate rise in the near future was very likely. This came shortly after the surprise 5-3 split seen in June. Despite the growing split, BOE chief has continued to keep a cautious tone and is likely to continue to do so in the near term. Indeed, news last week that the hawkish Forbes will be replaced with the dovish Tenreyro, strengthens the bank’s dovish camp.

However, a replacement is also needed for Hogg, who is leaving too, and there is still a risk of another hawk joining.  Alongside this shakeup at the BOE, there is also important data to come with Q2 GDP. This data will be particularly noteworthy given the contrasting pictures were shown by weaker consumer data yet stronger PMI readings.

So, with the risk of a hike growing, what would a rate hike mean for the British Pound?

• Secondly, looking at historical incidences of BOE rate hikes doesn’t paint quite so clear a picture. Following the beginning of the bank’s inflation targeting regime in 1992, GBP has weakened into hiking cycles on three of out of the five instances though it is noteworthy that GBP then tends to outperform once the cycle has already started.
• Firstly, it is important to note that GBP is extremely sensitive to rate spreads and the correlation between GBP and front-end rates has started to rise again after weakening at the start of the year. As a result of this breakdown, GBP actually rose above-spread pricing with 2-year rates suggesting that GBP/USD is still massively above fair value (around 15 big figures).
• Thirdly, it is important to distinguish between the removal of last year’s cut, which was deemed an emergency cut, and the commencement of a full hiking cycle. Indeed, comments from newly-converted dove Haldane last week, suggest that the former is more the case here and market pricing has been consistent with this view. 
• Fourthly, traders need to consider tightening in the UK against a backdrop of tightening elsewhere. Beyond stronger than anticipated pass-through of GBP weakness into inflation, a key reason for BOE hawks has been the recovery in corporate confidence. However, this recovery has been tightly linked with stronger global and European growth. Ig growth remains firm over an MPC rate hike then this would likely be partially offset by tighter ECB policy either via tapering or a rate hike.

In consideration of these reasons, it appears unlikely that a late summer/autumn hike would give GBP anything much beyond a temporary boost. The risk to this view is that the Ban goes beyond a removal of the emergency cut and commences a full hiking cycle.

However, this would likely have negative effects on domestic demand, which is still struggling, as debt servicing levels have remained near record lows despite increasing leverage and weaker house price growth. Indeed, the BOE announced this week that they would raise the counter-cyclical capital buffer to 0.5% from 0% and the capital buffer from 0.5% to 1% in November which will tighten the mortgage affordability tests for lenders. This is likely to further weigh on house prices.

Indeed, the BOE announced this week that they would raise the counter-cyclical capital buffer to 0.5% from 0% and the capital buffer from 0.5% to 1% in November which will tighten the mortgage affordability tests for lenders. This is likely to further weigh on house prices.

Technical Perspective

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GBP/USD continues to grind within its recent range. The key technical structures in place currently are the medium term bullish channel from last year’s post- flash crash lows and the short term bearish channel which can be viewed as a bull flag suggesting the potential for a topside break. Only a break below the rising channel low will negate this view.