Andrew Sentance departs - where does this leave the MPC?

Arch-hawk Andrew Sentance made his last MPC interest rate vote earlier this month, as his tenure comes to an end. He voted for a 0.5% Bank of England interest rate rise, with fellow hawks Andrew Weale and Spencer Dale both voting for a 0.25% interest rate rise. This left the voting pattern as six in favour of keeping rates on hold, and three voting for a rate rise.



Former Goldman Sachs economist Ben Broadbent is Sentance’s replacement, and comments last week suggest he is by no means as hawkish as his predecessor. In his appearance before Parliament’s Treasury Committee last week, he stated that if VAT and high commodity prices are stripped out of the headline UK inflation figure, we are much closer to the BoE’s official 2% target. These comments are not consistent with those of a ‘nailed on’ hawkish voter. He is likely to be viewed as a swing voter, and this could push expectations of a BoE rate rise back, or at least makes bringing expectations forward more difficult.

Spencer Dale has come out with some real hawkish rhetoric of late, stating that he was “not at all confident that the recovery has taken hold and will definitely power away. However, I'm even more worried about what's going on in terms of inflation.” Perhaps it is Dale that will replace Sentance as the sabre-rattler in chief.

As it is, the market has the BoE raising rates in its January 2012 meeting. There is so much that can change in this time that for us to commit to a specific month seems more than a little speculative. However, we currently would be sceptical of bets being brought forward to this year, based on the current performance of the UK economy at present and based on the removal of the hawkish faction’s most outspoken voter.


Richard Driver
Currency Analyst – Caxton FX



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Sterling enjoys a major boost from hawkish BoE Inflation Report

Mervyn King took the market by surprise this morning by indicating that the Bank of England could raise interest rates this year. So, after a session on the back foot yesterday, sterling has spiked aggressively against most of its major counterparts today, gaining a cent on the dollar and well over a cent on the euro.
Before today’s Quarterly Inflation Report, pessimism surrounding the UK economy was such that no interest rate rise was fully priced in by the market until January next year. Investors now seem confident that we will see some monetary tightening by the end of this year. Why? Not because of a more positive view of the UK economy, that’s for sure. Indeed, King expressed concern that first quarter growth was slower than expected and that the UK’s near-term outlook moving forward was downgraded.

The UK’s inflation expectations were upgraded, with the figure likely to hit 5% in coming months and to remain above the BoE’s official target of 2% for the whole of next year. We have already been warned that inflation could reach these levels, so why the huge response?

It was the somewhat hawkish tone of King that seemed to seal it. King has been distinctly dovish in the past, and it seemed like he meant business today, “Bank rate will rise at some point, it cannot stay at this level indefinitely.” He also stated that his May inflation forecasts were based on the assumption that interest rates will rise to 0.8% in the fourth quarter of 2011 and to 1% in the early part of 2012. So, a 25 basis point hike is now fully priced in for December.

Views surrounding BoE monetary tightening range from two rate rises this year (with the first in August) to none this year, and none next. Not to be fence-sitters, but we are somewhere in the middle. Today’s sterling positivity has been overdone in our opinion, we are more cautious about the UK’s struggling recovery.

Particularly in the absence of arch-hawk Andrew Sentance , the MPC seems likely to remain in wait for growth to come before raising rates. The picture will be clearer if last month’s slow in growth is shown to be temporary, as King indicates, or reflective of an even more fragile recovery than initially recognised. What’s more, the MPC has shown little concern with accusations that its weakening grip on inflationary pressures is calling its credibility into question. So despite King’s hawkish tones we'd prefer to wait for further evidence before bringing interest rate expectations forward.

Comments, as ever are welcome!

Richard Driver

Analyst – Caxton FX


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Sterling takes a pasting as UK inflation undershoots

What’s driving the currency markets more than anything else at present? Central Bank interest rate policy. What’s driving interest rate policy more than anything else? Inflation levels.

For this reason, you can see why the market response to today’s UK headline inflation figure for March has been so marked.

Data revealed that inflation in the UK has dropped from 4.4% to 4.0% the first monthly decline since July 2010 and the largest decline since February of that year. With oil prices (as well as other commodities) through the roof, we must admit we were expecting another rise, albeit a modest one. The figure is certainly welcome news to consumers and indeed the Bank of England (BoE), but it hasn’t done sterling any favours.

A fall in food and drink prices appears responsible for the monthly inflation drop. It certainly plays into the hands of Mervyn King and Adam Posen; they have for a long time claimed that inflationary pressures were temporary and today’s data supports this view.

Sterling suffered in the immediate aftermath of the news, falling sharply against the euro and the US dollar as investors scale back their BoE interest rate expectations. A May interest rate hike is now highly unlikely, and the current market consensus of an August rate rise seems altogether more probable. With inflationary pressures potentially easing, the MPC can sit tight and wait for the UK recovery to gain traction before shifting policy.

With UK economic figures still very inconsistent, evidenced this morning by poor retail sales, we now expect sterling to underperform for the remainder of this month. Sterling is looking decidedly vulnerable against the euro in particular, as the market has fully priced in another two ECB rate rises this year. These expectations may to some degree be dependent on eurozone inflation figures due to be released on Friday. With today’s UK data in mind, only a similarly sharp dip in eurozone inflation is likely to limit the single currency’s appeal.

Whilst arch MPC-hawk Andrew Sentance may well be fuming at today’s figures, the UK doves needn’t get ahead of themselves. UK inflation remains double the BoE’s target and if we see a strong UK growth figure for the opening three months of 2011, then a second quarter UK rate rise could return to view. In the near term, next week’s MPC minutes will interest the markets. However, a turnaround in sterling’s fortunes may well have to wait until the key GDP figure at the end of the month.

Based on today’s unforeseen inflation figures, we have put our BoE interest rate expectations back in line with the market at August, pending the GDP figure.

Richard Driver
Analyst – Caxton FX


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BNP Paribas plump for a May BoE rate rise, we disagree...

A interesting article in FT Advisor recently discussed one of the hot topics in the currency markets at present: - When will the BoE raise interest rates? A BNP Paribas economist is betting on a May rise, stating that “if they don’t act in May then I don’t think they will be able to raise it later in the year.”

We set out Caxton FX’s view last week and we are sticking to it, steadfast and defiant; the BoE will raise rates in June.

Discussions about a UK rate rise in April were dashed this month by an unchanged March voting pattern within the MPC and a distinct shortage of hawkish rhetoric. An April rise was made yet more unlikely following the events in Japan and the UK growth downgrade in the government’s annual Budget. So what about May? A May rate rise is by no means beyond the realms of possibility. This month’s MPC minutes did express a concern that inflation could exceed 5% in the near term, suggesting this could be a benchmark past which the BoE will be reluctant to tolerate further escalation.

Inflation currently sits at 4.4%, the next UK inflation updates comes on 12th April, which will be the inflation figure on which the May 5th BoE interest rate decision will be largely based. Therefore (stay with me), the inflation figure for April would have to increase by 0.6% for the MPC to finally be forced into biting the bullet on a rate hike. A month-on-month inflation increase of 0.6% has not been seen in over a year; it’s not unheard-of but the odds are that it won’t. This is all a bit statistical but it does suggest a May rate rise would be a surprise.

Perhaps more convincing is the argument that the MPC will remain in wait-and-see mode. The majority of policymakers want evidence of a stronger economic recovery. Indeed, we have seen sterling suffer in the past fortnight as sentiment towards the British economy has soured. The present outlook for UK GDP is weak and recent retail sales figures and consumer confidence data set alarm bells ringing. For a May rate rise, we imagine that a clean sweep of positive UK manufacturing, services and construction data would be required, in combination with an encouraging first quarter UK GDP announcement on April 27th. Whilst we do see negative perceptions of the UK economy as somewhat overdone, we are unconvinced the MPC will get the economic indications they are stubbornly waiting for.

In addition, we do not expect a further change in the voting pattern at the MPC’s April meeting – who are the fourth and fifth voters going to be I ask...? Two more MPC policymakers would have to be recruited to Andrew Sentance’s hawkish camp in the space of one month. Again this seems improbable; there have certainly been no indications of any further MPC hawks emerging in recent policymaker speeches.

There is also a political reason for delaying the rate rise. UK local elections are being held on 5th May and it seems unlikely that the MPC will announce a rate rise that would affect the political process, particularly as it would be detrimental to the incumbent Conservative government with whom the BoE work so closely.

As for the “May or not at all” comment, which the FT referred to... this really makes little sense, there will of course be a rate rise this year, there is nothing about the month of May that constitutes a deadline.

Richard Driver
Analyst – Caxton FX
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MPC Minutes dishearten investors but high hopes for change were misplaced

After a long time out of the spotlight, the UK again took prominence today as the minutes from the MPC’s March meeting were released this morning. In addition, we saw Chancellor George Osborne announce the UK’s 2011 budget earlier today. The former caught the eye but the latter left the market unperturbed.

Central bank interest rates are the real market-mover at present and an insight into policymakers’ views will always attract attention. The minutes revealed that Andrew Sentance’s hawkish camp failed to coax a fourth MPC member to join their campaign to increase interest rates. Had they succeeded in this, the outlook for a BoE rate rise as early as May would have been greatly improved, particularly in light of yesterday’s appalling UK inflation figures (4.4%!).

On release of the news, sterling dropped sharply across the board, and investors may well have been disappointed by the lack of any real increase in hawkish language adopted within the minutes. Indeed if anything, the tone reflected additional uncertainty following recent global developments, which will likely cloud the UK’s economic outlook.

Osborne’s budget announcement today contained a wide range of interesting material; the headline was probably Osborne’s downward revision of the UK’s growth forecast for 2011 to 1.7% (from 2.1% - itself an already downwardly revised estimate) but sterling has survived this hit relatively unscathed.

Sterling has actually lost little ground to the euro today as some bad news from the eurozone irritated the markets. It has been announced that the EU Summit this weekend will not be reaching a final decision on the ever-troublesome bailout fund. Given that the markets had grown in enthusiasm after initial progress at a preliminary summit, and that they would get a definitive answer this Friday, the delay of the decision until June seems to have frustrated euro-investors. Concerns have also mounted with regard to the Portuguese Parliament’s vote on its government’s austerity measures, which if rejected will almost certainly see its PM resign, and could well be the catalyst for a Portuguese bailout.

At present, sterling remains in limbo around €1.15 with another trigger needed to define direction.

Richard Driver
Analyst – Caxton FX


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UK interest rates left unchanged - expect a rise in June

It is no secret that central bank interest rates represent the main driver of the foreign exchange market at present. So why isn’t today’s monthly UK interest rate announcement an exciting one? Well, because we knew that the 0.5% rate would be maintained, as it has been every month for the past two years.
UK inflationary pressures are soaring at double the BoE’s target and given the ECB’s recent hawkish indication of an April rate hike, there has been growing demand for the MPC to take similar action to tighten policy. However, the BoE is wary of destabilising the economic recovery at this stage and we don’t see rates changing until June. Nor should they; we really need to wait until June to know what impact the UK’s austerity measures will have on British growth.

However, it will be interesting to see what the minutes of the MPC reveal. At last month’s MPC meeting, resident hawks Andrew Sentance and Martin Weale recruited Spencer Dale to their cause, but remained outnumbered by 6:3. We may see a fourth vote added in favour of a rate rise this month, but we still don’t envisage the BoE raising rates before June - by which time there should be firmer evidence that economic conditions are improving.

Given that the MPC was expected to maintain rates, we have seen a somewhat surprising drop in value for sterling, falling by over a cent against the dollar to its lowest point in almost a fortnight. However, the focus for the market will now turn on the EU summit this weekend, where officials will attempt to work towards an agreement on the eurozone’s fiscal troubles. After a week where the euro has suffered somewhat against its major counterparts on the back of flare-ups in Greece, Portugal and now Spain, the single currency would benefit hugely from some progress on the peripheral debt issue.

Richard Driver
Analyst – Caxton FX
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Pound down as GDP revision adds further woe

As suspected – revision of our GDP figure was less than positive (quite literally) as official data showed today that underlying growth was marginally weaker than previously thought in Q4, having been revised down to -0.6% from -0.5%.

The figure will add further credence to the 6 dovish leaning members of the MPC, who wanted to wait and see how the economy faired before jumping in to vote for an interest rate increase, but what will the implications of this be?

The market reaction saw the pound fall further across the board, reaching a month low versus the euro as traders took advantage of the figure and liquidated their long sterling positions. They now have to assess whether this dip in growth will change the prospects for the interest rate outlook.

It’s unlikely that a figure from last year will have too much bearing on rate expectations, particularly as Q1 2011 has gotten off to a solid start. Andrew Sentance et al I’m sure will merely shrug this figure off and put it down to snow-related disruptions. Traders have however pared back expectations for a 25 basis-point increase from May to June.

We now look forward to another busy week. Highlights include Britain’s PMI figures across the manufacturing, services and construction sectors due on consecutive days mid-week. After January’s positive results, (which lent a helping hand to the pound), we could well see further positive figures this month, buoying hopes that the economy will return to growth in the opening quarter of the year. We also have three central bank announcements on the calendar: the Reserve Bank of Australia , Bank of Canada and European Central Bank. However, no changes are expected.

The week’s headline comes right at the end in the form of US non-farm payrolls. Each month the hype in the market gets inflated as the release approaches, but more often than not price action is underwhelming. Nonetheless, US non-farms nearly always bring about an excitable market – no let up volatility approaching just yet.  

Any thoughts or comments are always welcome!

Edward Knox

Analyst - Caxton FX

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Uncertainty is certainly harming pound

Markets dislike uncertainty, and that is the only certainty in the markets right now – this seems to typify market action over the past few days, as we head towards the end of a topsy-turvy week.

Sterling has had a rather unimpressive day, falling sharply against its counterparts on the back of a broad rise in risk aversion. A spike in the price of oil as tensions mount in the oil rich Middle East and North Africa is driving investors to safe haven currencies with the Japanese yen and the Swiss franc the outperformers at present.

The pound has rallied since the start of 2011 on the back of higher inflation and heightened speculation that the BoE will raise rates sooner than most. However, it seems that after the release of yesterdays minutes investors may well be reassessing the state of the UK economy and asking themselves whether monetary tightening will threaten the UK economy’s fragile recovery.

Arch hawk Andrew Sentance is certainly of the opinion that raising interest rates is the way forward, as was detailed in my recent blog post.  The increased hawkishness in the MPC camp, led by Sentance, has been supportive for the pound in recent times, however he is due to leave the MPC in May. So what effect will this departure have on the BoE’s stance? Vicky Pryce, one of the candidates to succeed him, pointed out the risks of raising rates too soon in a column this week – this won’t sit too well with investors who have already priced in an imminent rate hike.

David Miles also added to sterling’s woes in the short term, announcing yesterday evening that the best way to control inflation would be to “raise interest rates gradually,” contradicting Sentance’s argument that there should be an immediate rise of 0.5% in the base rate.

Uncertainty over the prospects for the UK economy and the evident dilemma facing the Bank of England looks set to keep sterling choppy. We will now look forward to the GDP revision tomorrow morning (first estimate -0.5%) – something tells me that we will be in for a rather underwhelming figure. Even a small upward revision would still leave the economy in contractionary territory, and is unlikely to prove the catalyst for renewed sterling strength. 

Edward Knox

Analyst - Caxton FX

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Minutes revealed to muted reception

So, as the market had more or less anticipated, a third MPC member has jumped on the hawkish bandwagon. In the BoE minutes, released today, it was revealed that Spencer Dale was the latest member to recognise the threat of rising inflation, throwing his hat in the ring with arch hawk Andrew Sentance and Martin Weale in voting for an immediate interest rate rise.

Much of this had already been priced into the market as analysts deciphered clues from speeches given throughout the last few weeks; in particular Mervyn King’s acknowledgement last week that there was an unusually diverse array of opinions amongst the Committee.

Perhaps then the market was slightly underwhelmed when the results showed a 3-6 split, with sterling briefly enjoying a knee jerk boost before dropping back again against the euro. The pound did however enjoy a rally against the US dollar as the minutes firmed opinion that the Bank of England will raise rates sooner than the Federal Reserve on the back of inflationary pressures, which partially offset ongoing concerns about political tensions in the Middle East and North Africa.

The minutes also revealed that Sentance on this occasion stuck his neck out and ramped up his argument that inflation poses a far bigger risk than the bank is willing to recognise by voting for a 0.50% increase in the base rate as opposed to the more traditional 0.25%. The standard pre-release rumours had covered this eventuality so again there wasn’t too much made of his vote and it’s unlikely to prove any more of a compelling argument for those policymakers still sitting on the fence.

With the hype and drama of the minutes now passed the market’s focus will shift to Friday where the UK’s second estimate of fourth quarter GDP is due. At an initial estimate of -0.5%, most are hoping that there may be an upward revision. However, even if there is it is unlikely to be greater than a factor of 0.2%, leaving the figure in contractionary territory, much to the discomfort of sterling bulls who appear to be losing their preeminent position!

Edward Knox

Analyst - Caxton FX

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Sentance gives sterling a boost

It seems that this interest rate saga is keeping the market on tenterhooks, with a new twist hitting the headlines this morning. In a nice follow up to my recent blog, the story continued today as Andrew Sentance, a resident hawk in the MPC, more or less rebuffed Governor King’s speech which claimed that the market was “getting ahead of itself” in anticipating an interest rate hike.

In response sterling recouped some of its losses from yesterday, up against most of its major counterparts as Sentance slammed the Central Bank’s economic forecasts, accusing them of understated inflation risks. In his most outspoken attack yet, Sentance made clear his view on the Central Bank’s poor track record in forecasting inflation, and suggested that monetary policy would most likely need to be tightened faster and “more than the markets currently expect” to combat record inflation.

Sentance argued that raising interest rates would bolster the value of the pound, which would help to offset the rising cost of imported commodities – a key contributing factor to the doubling of the banks inflation target.

Although this morning’s comments will no doubt have offered support for sterling, the underlying problems of high unemployment and low real wages may well be reflected in tomorrow’s retail sales data. The market then will now look forward to the MPC minutes, which will be released on Wednesday with baited breath: will we see a third vote in favour of a rate rise? Not just yet would be my guess.

Edward Knox

Analyst - Caxton FX

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What next for Sterling?

The MPC meetings minutes were released this morning much, I’m sure, to the embarrassment of policy member Martin Weale who decided to dance to the tune of raising interest rates. He now joins Andrew Sentance – who has been voting for this policy shift for the past 4 months  – and will probably be rethinking his decision after the release of Britain’s shock GDP figure.

Mervyn King meanwhile, smug in the knowledge that he refused to bow to inflationary pressures, used a speech yesterday to defend the Central Banks ultra lose monetary policy in the face of high inflation. He reiterated that the economic recovery would be ‘choppy’ (understatement if ever I saw one), and that real wages would be heading lower. I’d imagine that King’s Speech will not have been received quite as well by the public as its multi Oscar nominated names sake.

The question now is; what will become of the pound if these figures are to be relied on? How much of a toll did the weather take on these preliminary results? After all, the economic impact of the snow is extremely hard to quantify. My feeling is that the figure of -0.5% shouldn’t be taken at face value. Certainly the recovery has been blown off course, but we should wait for the second and final estimates before completely reassessing the situation. The figure is at odds with the PMI (Purchasing Managers’ Index) surveys and the National Statistics Office has been wrong before, notably coming in 0.4% wide of the mark in the final quarter of 2009. A similar revision this time around could well be on the cards.

Nonetheless, the pound must still deal with the dual hangover of weak economic growth and high inflation: ie stagflation. This is not a concept that will rest too comfortably for the pound. Whereas the expectation of higher interest rates gave sterling a boost in the early part of the year, that eventuality has lost all credibility. Indeed, the prospect of such a move from the Bank of England looks about as likely as Andy Gray presenting Woman’s Hour.

With key US announcements due today and Friday, the market should avert its attention from the UK economy at least in the short term. However, any lasting relief for sterling will depend on a fresh wave of eurozone concerns or these lowly €1.15 levels could endure for now.

Edward Knox

Analyst

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