BoE scores one nil against sterling bears

Summary

Bank of England policymakers have scored a victory against complacent sterling bears.

August goes ‘live’

The MPC has successfully wrested back the interest-rate initiative from the market with two surprises in a statement that was widely expected to be dull. The MPC’s chief economist Andrew Haldane delivered the biggest by switching his previous vote to hold.  The shock to complacent sterling bears sent the pound against the dollar on a blistering stop-run in one of the fastest moves recorded. Policymakers were also careful to further underscore earlier signals of increasing economic optimism. The view of first-quarter weakness being temporary was “broadly on track”. Rising intent to hike now spotlight’s August as fully ‘live’ for 25 basis points of further tightening.

More than a tweak

New guidance on when the £435bn stock of government bonds would begin to be reduced was also unexpected. The Bank rate is now expected to be at 1.5% when reduction begins. Previous guidance foresaw a 2% rate. The new assessment still implies a lengthy campaign of six 25-basis points rate rises, but the implied policy switch is clear. A slightly narrower horizon to when ‘emergency’ measures unwind backs policymakers’ confidence on longer-term economic capacity. The change is also another signal of resolve to reach the inflation target faster. In one clean stroke then, policymakers have gone a long way to redeeming confusion from their spring swerve. The risk of lasting impact to MPC credibility, regardless of necessity, is much reduced.

Bears lick their wounds

Soft outcomes from the BoE switch go hand in hand with another hard lesson for sterling bears, which may have further to run on Thursday. For one thing, the impact of cable’s 156-pip two-hour surge will echo for days, given clear bias in short-term positioning to the downside. The Dollar Index’s 11-month peak looks even more like a spike high now, crystallising a lasting dent on sentiment. The gauge reversed more than 65 ticks to stand clearly in the red before steadying at 94.87. Sterling crosses largely reflect the same damage to the bear case against the pound. The ultimate prize though remains $1.33, 43 pips from Thursday’s high. The possibility that sterling might extend its move to reach there intensifies attention on the evening’s event further.

Carney in the spotlight

Sterling exchange rate volatility could well come back for a second bite tonight. We expect many Thursday evening plans to change now amongst traders, ahead of BoE Governor Mark Carney’s Mansion House speech. Speculation around the speech’s content will play its own part in keeping sterling hot late this evening. Even beforehand, three successive new hourly highs since the Bank’s statement suggest only a minority expect Carney to talk sterling down a bit. After all, rates futures still price less than 50% probability of a 25-basis point rate rise in August. Only for December’s meeting is 25bp of tightening close to fully priced. As such, whilst the market has seen the light about a rate rise this year there’s more convincing to do about when.