BoE rate cut odds ramp as Carney plays catch-up

Dovish comments

Last week, the BoE Governor mentioned that “there is a debate at the MPC over the relative merits of near-term stimulus” signalling that the combination of conventional and unconventional tools would equate to around 250bps in cuts. Despite these comments, market-implied cut probabilities remained relatively subdued, with up to a 60% chance of a September cut, jumping from 40% prior.

Since then two more members of the MPC have hinted at a more dovish stance. Tenreyro suggested that she may support a rate cut “in the coming months”, in the absence of signs of recovery in the UK economy, while Vlieghe needed to see an “imminent and significant improvement in the UK data” to undermine the case for an immediate cut.

Weak data

These remarks were followed by weak macro data showing the economy shrank 0.3% in November ahead of the general election, against a median forecast for flat growth. GDP growth is clearly weak, having fallen for two consecutive prior months. PMI composite figures also suggest the economy remains fragile, with the employment index pointing to slower job’s growth ahead. Indeed, unemployment stopped moving lower last year. Of course, waning inflation out this morning is also pushing the rate cut case.

We think it is still early days for additional action as the post-election data is limited and if anything, points to improving sentiment. Real wage growth remains solid and leading investment indicators and consensus 2020 GDP forecasts have all been turning higher, after positive revisions to GDP in prior months. There is a clear risk that policymakers may be overemphasising the outdated data ahead of the election. The BoE also expect the headline inflation rate to fall by the Spring, owing to temporary effects.

Market Pricing…too far (for now)?

Nonetheless, markets have turned abruptly, as sterling rate traders are prone to do and are now pricing in a 59% chance of a rate cut at the January 30 meeting, up from 45% before the GDP report and only 5% last week before Carney et al spoke. A full 25bp cut is now fully priced by June, after the 3-year lows seen in CPI today.

The key longer-term risk to the UK economy remains the progress in trade negotiations with the EU which will kick off in earnest in early February. Before that, next week’s January PMI will be important in cementing the Bank’s near-term outlook. Carney hinted last week that another agent’s report may be needed before confirming his view, which leaves Andrew Bailey to potentially move rates later in the first half of the year at the May meeting.

With the focus on the economy and the BoE’s reaction function, EUR/GBP may target 0.87 on any further repricing. Will the post-election top around 0.8592 be too much to get through? The corresponding low in cable at 1.2905 will be important in determining if sterling does bounce amid this recent disproportionate risk assessment.