Inflation Report preview Carney and co to remain on hold for now

It’s Super Thursday for the Bank of England this week, when it will announce interest rates and release its latest Inflation Report at midday on 3^rd November. Interest rates are expected to remain unchanged and the Bank’s Inflation Report will be watched closely to see if the contours of its economic forecasts have changed.

Carney and co. likely to park interest rates for now.

Looking at interest rates first, only 2 out of 58 economists polled by Bloomberg expect the BOE to cut interest rates at this meeting. The market is currently pricing in a mere 5% chance of a rate cut on Thursday, back in September there was a 25% chance of a cut. As UK inflation and growth have both beat forecasts in recent weeks, UK interest rate expectations have drifted higher. Currently there is only an 8% chance of a rate hike by the end of the first quarter, when Theresa May is expected to trigger Article 50.

Traders will be looking to the BOE this Thursday for confirmation that their position on UK interest rates remaining on hold for the long-term is correct. If the Bank shocks the market by signalling that more rate cuts are to come, then we could see a major readjustment of positions, with bond yields and the pound both falling sharply.

Carney chilling on interest rates

On balance we think that the Bank is likely to signal that interest rates are likely to remain steady and the Bank’s QE programme is on hold for the medium-term. However it may add a massive caveat to that view – if all hell breaks loose over the triggering of Article 50 in the first quarter of 2017, then the Bank is likely to signal that it is ready to act to provide further stimulus to the market if needed.

To revise up or down, that is the question…

The focus for the Inflation Report will be the BOE’s growth and inflation forecasts. On balance, after the recent uptick in both GDP and price data, the BOE is likely to revise up its forecasts for 2017. Its forecast back in August expected growth to slow to 0.8% next year, if this is subject to an upward revision then we may see a sharp rise in sterling, UK bond yields and potentially the FTSE 100.

Of course, the MPC may argue that the better than expected economic data in Q3 is a sign that the Brexit slowdown has been merely delayed, so there is a chance that the BOE could revise down its growth forecast for 2017 even further. It may also hint that further easing will be required in the future, which could trigger a major readjustment of the market’s interest rate expectations. However, we don’t think that the BOE will want to spook financial markets at this stage, and a mild upward revision to GDP, and a sharper revision higher for inflation, is likely to be on the cards.

Carney to dodge questions about future

The backdrop to this report has not been the UK economy, but the Governor of the Bank of England’s perceived spat with Westminster over his economic fears for Brexit, and his decision to extend his term as Governor for one more year, until June 2019. We expect the press conference to focus on potential political threats to the BOE’s independence, and journalists may try and gain clarity from the Governor about why he is not staying at the helm of the BOE until the full term ends in 2021.

This could prove a distraction from the main event – the GDP and CPI forecasts

Market moves:

Overall, we think that a signal from the BOE that policy is likely to remain on hold for the foreseeable future and a mild upward revision to next year’s GDP forecast, may trigger some short term upward pressure on the pound and UK Gilt yields on Thursday. GBPUSD may move back towards 1.25 – the highest level since 7^th October, and a key area of resistance. We think that GBP/USD is likely to remain in a tight range between 1.20 and 1.25 ahead of the triggering of Article 50 next year. For a more sustained move to the upside for GBPUSD, potentially back towards 1.30, then we may have to see a decidedly more upbeat outlook from Carney about the UK’s post-Brexit economic prospects. We believe that this is a step too far for Carney and co. at this stage, and instead any upward revisions to growth will be cloaked in a huge caveat about the uncertainty of life outside the EU.