The Bank of England kept interest rates on hold at 0.5% today, as it has done every monthsince March 2009. In reality, there wasn’t even an outside chance of a UK rate rise - the UK growth figures have just been too poor of late. Long-term sabre-rattler Andrew Sentance left the MPC last month, and now Mervyn King and his MPC doves are more in control than ever. Even if they did wish to change stance, the MPC would struggle to justify a rise before 2012, with growth so weak and household incomes so squeezed.
The IMF cut its forecast for UK growth in 2011 from 2.0% to 1.5% earlier this week, and we could well be in for a second quarterly growth figure as low as 0.2%. Mervyn King has repeatedly indicated that the UK’s soaring inflation levels are down to temporary factors that will subside next year, so the MPC are likely to ride out these high prices. With UK growth so soft, King is loath to hit the British economy with higher borrowing costs. Indeed, this morning’s UK trade balance data suggested consumer demand is really suffering at present, which took the shine off a narrowed deficit.
Unsurprisingly, the market didn’t respond to the BoE’s announcement; the release of the MPC minutes in a fortnight is likely to prove more market-moving. The market didn’t respond to the ECB’s unchanged 1.25% interest rate either. However, the market has moved since Trichet's press conference, and it has been a significant move.
Trichet delivered on the “strong vigilance” message with regard to upside risk to price stability, so a July rate rise is now more or less guaranteed. However, the euro has suffered a substantial slide on the news. The July rate rise was clearly fully priced in and traders have obviously seen now as an opportunity to take profit; the euro has given away half a cent to sterling, and over a cent to the US dollar. This may also be a reflection of some disappointment that Trichet refused to give any signal as to rate rises beyond July.
Despite the euro’s fall, the long-term outlook for a strong euro remains intact. Though with the market likely to refocus on the Greek situation in coming sessions, the euro could have some further downside in the short-term. Only when a Greek resolution arrives is the euro likely to really kick on from here. Sterling still looks fundamentally weak; none of its gains today have been made on its own merits.
Richard Driver
Analyst – Caxton FX
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