The BOE Owns Today, But Tomorrow Is A Different Story

The Bank of England owns today, though tomorrow will be about the US jobs report. The BOE disappointed the market last month by not immediately responding to the UK referendum. It had laid out a somber economic and financial scenario as a risk case if the UK chose to leave the EU. At the time, and even after the referendum, some accused Carney of being too partisan.

The Bank of England Governor did seem to be exaggerated when he claimed that the UK economy was slowing in the spring due to holding the referendum in the first place. We have subsequently seen the preliminary estimate of Q2 GDP which show that the economy activity had increased a little over Q1.

However, what that risk scenario that the BOE is presented is now more or less the base case. The forecasts will be updated today, but the sobering surveys (PMI and CBI) and NISER projections are fairly consistent with what the BOE had anticipated. There must be some calibration between the forecasts, even given a confidence interval around them, and the actions the BOE takes or suggests it can take. 

That said, the inflationary pass-through of sterling’s depreciation (import and consumer prices) is unlikely to deter significant action. The impact from sterling is temporary and price pressures are beginning (when the Brexit shock hit) was just above zero. 

In terms of policy, there are three elements. First is the base rate itself. It stands at 50 bp. The failure to cut it would be a major disappointment to the market at this juncture. Most look for a 25 bp cut. In the past, Carney (though perhaps it is also an institutional judgment) has shown a reluctance to cut rates too close to zero, let alone negative interest rates. There are some calls for a larger than 25 bp cut; we suspect the BOE is not persuaded that the additional marginal rate cut will have much impact.

Second is asset purchases. The market is nearly split on whether the BOE announces a new asset purchase program (QE). Those that do expect QE are mostly anticipating a GBP50-GBP75 bln program over several months. There has been some talk that the BOE could buy corporate bonds. Here too we think the odds do not favor innovation when it is not necessary.