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21/01/2015: Bank of England shift in sentiment will not help sterling

The Bank of England has shifted back towards the doves. The voting composition of the Monetary Policy Committee has changed from seven voting for no rate change and two voting for a rate hike, back to a position of nine nil again. The two hawks (Martin Weale and Ian McCafferty) have switched allegiance (at least, for the time being) and the doves rule the roost. This may now have bearish implications for Cable.

doves two

The plummet in the oil price in the past 6 months, in addition to falling food prices and lack of pricing pressures from trading partners such as the Eurozone has meant that inflation has been falling in recent months. Consumer Prices Index, the measure that the Bank of England is benchmarked against recent fell below the 1.0% threshold that now means the Bank is now more than 1% below its target inflation rate. Although the Bank of England is meant to be more forward looking than the near term inflation rates, the fact that economic indicators have been rolling over in the UK for the last few months would not have been lost on committee members.

A look at the interest rate futures (ie. Short-Sterling Interest Rates and Eurodollar interest rate futures) shows a significant change that the market has taken on board in the past couple of months with regard to the UK and the US. Whilst the months for the market’s expectation of US rate hikes have only marginally been pushed out (the market is still pricing in a rate hike of between October/January, or 10 to 12 months time), the UK has been pushed out significantly.

In early November, the expectation had been that the Bank of England would be looking for its first rate hike in the middle of 2015, just a couple of months down the line, this expectation has now been pushed back to March 2016 (the MPC meeting minutes have driven a big shift in sentiment in just today alone). Furthermore, the pace of the rate hikes has also been significantly slowed, with the market not expecting rate at 2.0% until March 2020 (previously this had been September 2017).

This dramatic divergence between the rate expectations for the US and UK goes a significant way towards explaining why sterling has dropped 5% against the dollar (Cable has dropped from c. $1.5900 to $1.5110 today) since early November.

GBPUSD   21012015

Should this divergence in market’s expectation on interest rate futures continues to diverge it can be expected that Cable will comes under further selling pressure. Selling into strength on Cable seems to be a viable technical strategy, and this is backed up by the movement in interest rate futures.

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At Hantec Markets Ltd we provide an execution only service. Any opinions expressed by analyst Richard Perry should not be construed as investment advice or an investment recommendation. This report does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. Forex and CFDs are leveraged products which can result in losses greater than your initial deposit. Therefore you should only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved, seeking independent advice if necessary prior to entering into such transactions.