Foreign exchange markets expect negative rate option will be kept in reserve, medium-term optimism would support the Pound Sterling
Consensus forecasts for the Bank of England meeting are that there will be no immediate policy changes. Markets expect the bank will decide that negative rates can be deployed, but not be used at this stage.
Deviation from this consensus will lead to big pound Sterling moves. Indications that negative rates are unlikely would support the Pound Sterling, although dollar moves will also be crucial for Pound-to-Dollar (GBP/USD) exchange rate moves.
Sterling has faded into the meeting with GBP/USD below 1.3600 amid dollar gains and positive rhetoric would provide currency support.
Currency markets expect green light for negative rates
The BoE will release its latest policy decision on Thursday and publish an updated Monetary Policy Report.
Rabobank noted; “We expect the BoE to leave the policy rate at 0.10%. We also expect the central bank to stay the course on its asset purchases.
This is the consensus view, but a crucial element is that confidence in the outcome is low.
Nomura commented; “The Bank of England’s February meeting looks set to be a particularly interesting event. Not because of any anticipated adjustment to monetary policy, but rather because of what the Bank says about the potential for including negative interest rates in its toolkit.”
As well as the possibility of further easing measures, updated forecasts and forward guidance will be important elements.
In particular, the bank is expected to release the results of its survey into the operational feasibility of negative interest rates.
The first aspect will be whether the bank decides that negative rates can be deployed. The second element is whether they will be used now or in the future.
If the bank concludes that negative rates are not operationally feasible, the argument will end there.
ING commented; “The conclusion to the PRA’s consultation on the feasibility of negative rates is likely to officially allow the central bank to cut its Bank rate from 0.1% currently to below 0% if necessary.”
Goldman Sachs added; “We therefore expect the MPC to indicate that it sees a moderately negative effective lower bound and that further rate cuts are feasible, even though a bank rate cut was not judged to be appropriate at this time.”
Implementing negative rates is still a complex issue
If the bank gives a green light to the potential deployment, markets will have to assess the probability of a move even if there is no actual decision at this stage.
Nomura added; “We expect the Bank to go further and announce that, based on this review, negative rates can now be used if required, but at the same time admitting that deploying this tool is not without its risks.”
ING does not expect further easing; “We also think the central bank will refrain from easing further. A rate cut would take a long time to impact the economy. By that time, the recovery will be on a much firmer path and will not require additional monetary support. In that sense, the window for a cut to benefit the economy may have already closed. Ironically, the day the Bank officially adds negative rates to its toolbox might also be the day the market prices out cuts.”
David Madden, market analyst at CMC Markets commented “We could hear Mr Bailey try and distance himself even further from the idea of negative rates.
Forward guidance, economic outlook in focus
The bank will publish updated forecasts for growth and inflation.
Deutsche Bank’s chief UK economist Sanjay Raja focussed on the potential downgrading of forecasts; “The Bank's November MPR projection for 2021 was always a tad optimistic at 7.25%, likely making a downgrade inevitable.”
Marshall Gittler, Head of Investment Research at BDSwiss Group, expects a dovish statement; “For example, in their December statement they said “If the outlook for inflation weakens, the Committee stands ready to take whatever additional action is necessary to achieve its remit.” They could be more specific than that this time, adding “including cutting rates to zero or below,” or something like that. Otherwise, I expect another unanimous vote to keep rates and the pace of asset purchases unchanged for now.”
Unicredit took a more optimistic stance based on vaccine optimism; “It seems likely that the MPC will now judge that the risks to growth are less skewed to the downside, rather than bringing forward the date it expects the economy to recover its pre-crisis level.
Unicredit also point to upside inflation risks which may prompt caution; “Inflation is set to jump in the spring, as the VAT cut expires at the end of March and the large fall in energy prices drops out of the annual comparison.”
Citibank commented; “We still expect a 20bp rate cut to -0.1% but in August at the earliest. For now, it seems the MPC’s main aim is to guard against a premature rise in yields in the front-end – by keeping negative rate possibilities alive (but not necessarily implementing them).”
Bailey’s tone on the outlook also a key element
The comments from Governor Bailey will be important. In particular, markets will be watching the degree of confidence in the medium-term outlook.
MUFG expects the bank to look through short-term weakness and keep rates on hold. It adds; “The most bullish potential outcome for the pound would be if the BoE leaves the key policy rate unchanged, and the consultation with lenders further dampens speculation over negative rates in the near-term. It could open the door to further GBP gains lifting cable closer to 1.4000 and EUR/GBP towards the mid-0.8000’s.”
RBC Capital Markets added; “Markets are still priced for a significant risk of negative rates before year‐end and if the hurdle for cuts is perceived to be higher, GBP could extend January’s modest gains.
TD Securities noted; “GBP should see a modest lift in our base case as the MPC signals patience on negative rates. Beyond the MPC, however, we think upside risks are limited against the USD and think the balance is increasingly skewed to the downside in cable (GBP/USD). Instead, we think the center of gravity remains lower in EURGBP for now.”
Westpac added that the bank; may downplay NIRP as vaccine rollouts lift prospects for H2 21. GBP/USD should find support ahead of 1.35.