On Thursday 7th March 2013 at 1200 GMT/ 0700 ET the BOE will conclude its March policy meeting. The market expects the BOE to keep interest rates on hold at 0.5% and asset purchases steady at GBP375 billion.
We agree with the market consensus; however we think that there is a larger margin for error due to the shift in voting patterns at the Monetary Policy Committee (MPC) at the February meeting. Back then three members voted for more QE, including Governor Mervyn King. In the past, whenever King has been out-voted on QE the rest of the MPC has acquiesced the following month. Thus, although not our base case for this month, we think that the BOE could embark on GBP 25 billion of new QE on Thursday.
Earlier this month, deputy governor of the Bank of England touted the idea of negative interest rates to try and kick start the UK’s economy. He referenced cutting the deposit rate – the interest paid to banks that leave excess reserves with the BOE. However, we don’t think his idea will float with other participants. The prospect of negative interest rates when inflation is already running above target could cause some concern among policy members.
The reason why we think the BOE will remain on hold this week is twofold. Firstly, we think that elevated levels of inflation will cause some MPC members to hold fire on QE to see if inflation falls in the coming months, as it has done in the Eurozone. Secondly, although the manufacturing and construction sector PMI’s for February were dismal and fell deep into contraction territory, the key service sector PMI defied expectations and actually moved higher in February. This could calm nerves about growth for now.
Overall though, the UK economy is still in trouble, inflation is running high and the growth outlook is weak. The threat of a triple-dip recession still lingers, especially if there is another flare up of sovereign concerns in the Eurozone. Added to that the BOE Funding for lending (FLS) joint programme with the UK government has not had a big impact on the market. Out of GBP70 billion of cheap funds available for the banks to lend to the wider economy, less than GBP 14 billion has been used since Q3 2012, and consumer lending in the second half of 2012 was flat to slightly lower. This supports further QE in our view, and we think that an era of looser monetary policy from the BOE is on the cards especially when new governor Mark Carney takes over in July.
The prospect of looser monetary policy from the BOE has been a main theme in the FX world in 2013, and has helped to push the pound down 6% since the start of the year on a broad-based basis. Thus, since we don’t think the BOE will take any new action at this meeting, we could see the pound extend its recent recovery. GBPUSD dipped below 1.50 last week, which now looks like a major support level, while 1.5200 has stymied the bulls. If the BOE does not embark on more QE then we could see a further extension of the relief rally back towards 1.5350 in the medium-term. We also think it could weigh on EURGBP, which has also been a beneficiary of GPB weakness this year. 0.8550 then 0.8530 are short term support levels.
If the BOE does embark on more QE then we think downside could be limited, especially if it is only a token amount like GBP 25 billion. In GBPUSD support lies at 1.5030, 1.4980 and 1.4930.