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Research Note: Bank of England (BOE) Interest Rate Decision
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Summary Outlook: The Bank of England releases their next interest rate decision on Jan 8, 2009 at 0700 ET/1200 GMT. We think the BOE will ease rates more aggressively than markets are currently forecasting, and we look for 75-100 bps of easing against the consensus of only 50 bps. Our view is based on ongoing deterioration in UK economic data, weak UK and European outlooks, and continuing difficulties in the British banking sector. As recently as The Week Ahead from this past Friday, we viewed a more aggressive BOE cut as GBP positive, but GBP has rebounded sharply since then (GBP/USD from 1.4450 to 1.5250 and EUR/GBP from 0.9580 to 0.8990) so we think the GBP-positive scenario is now largely priced in.
In light of current levels, we think GBP is likely to be sold regardless of what the BOE does:
- If the BOE cuts by only 50 bps or less, the GBP -rebound will be short-circuited by fears of a longer and deeper UK recession, which is likely to be highlighted by the MPC statement.
- If the BOE cuts by more than 50 bps (the more they do, i.e. 75 bps or 100 bps, the more this dynamic should be amplified) the market will likely take profit on the positive GBP scenario and react to the larger than expected rate cut with expectations of zero interest rates ahead.
Trading Strategy: We like to use strength between 1.5200/50 to establish a short position in advance of the BOE announcement. A cut of 50 bps or less may see GBP rally initially, and we would look to add to shorts on strength between 1.5300/50, for a short average rate between 1.5250/1.5300. We would stop out over 1.5430, for a maximum risk of between 180/230 pips. Our initial take profit objective is at 1.4950, but we'll instate a 100 pip trailing stop if 1.5100 deals, as the potential downside reaction is extensive if GBP reacts at all as the USD did after the Dec. 16 Fed rate cut.
Economic Analysis: From a fundamental standpoint, rate cuts are likely to do little in terms of eliciting any quick rebound in UK economic activity. The fact remains that the outlook for growth continues to worsen. Contemporaneous indicators such as consumer confidence and home prices pushed into fresh cycle lows in December -- of 47 and -15.9%, respectively -- and suggest a pretty bleak consumer spending environment into the first half of 2009. Employment also continues to worsen and this coupled with the overall freeze in the consumer lending pipeline will only make things worse in our view. It is no longer the cost of debt, but rather the ability to finance debt, that matters. Thus lower rates will do little to alleviate the upcoming economic pain. We expect the MPC statement to highlight these downside risks to the outlook and open the door to speculation of additional rate cuts in the months ahead.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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