GBP: BoE to set the tone - ING

The pound’s sharp rise and fall over the past month should be a warning shot to the BoE that markets are still struggling to get to grips with their policy reaction function in a post-Brexit world and what policymakers choose to signal at the May ‘Super Thursday’ meeting could set the tone for GBP markets over summer, suggests Viraj Patel, Foreign Exchange Strategist at ING.

Key Quotes

“Recent wild swings in GBP are somewhat indicative of an “all or nothing” sentiment when it comes to further BoE rate hikes (“all” being two or more rate hikes in 2018 versus “nothing” being that the Bank will not hike again). There is a middle ground, which we expect to be reiterated at the May meeting; the combination of a 7-2 split MPC vote (two rate hike dissenters), the Bank downplaying the soft 1Q GDP data and a reiteration by Governor Carney that another rate hike this year remains "likely”. This should be enough to provide a modest uplift to short-term UK rates following the recent scaleback – or at the very least keep the curve supported where it currently sits.”

“The decline in GBP/USD to 1.35 looks overcooked relative to the more tempered BoE policy rate expectations. This – coupled with cleaner positioning and relatively limited sentiment for additional downside – means that we think the risk-reward favours GBP/USD upside going into the May BoE meeting. Signs that the BoE tightening cycle remains intact could lift GBP/USD up towards 1.3600 – while keeping EUR/GBP supported around 0.8750.”

“We do see tail risk outcomes on either side. A subtle hawkish surprise for GBP markets would be a 6-3 MPC split vote, which would give greater support to an August BoE rate hike (currently 50% priced in). An additional hawk joining the rate hike dissenters (with Chief Economist Any Haldane or external MPC member Gertjan Vlieghe the most likely candidates) may also give greater conviction to the MPC's medium-term hawkish bias – especially with resident hawk Ian McCafferty's term coming to an end after the August meeting. A 6-3 MPC split vote scenario (with three rate hike dissenters) could see GBP/USD moving up towards 1.3700.”

“Bottom line: We think GBP's fall in recent weeks - especially against the USD - looks overdone relative to the adjustment that we've seen in short-term UK rates. We remain medium-term GBP bulls, though acknowledge that the short-term outlook will be a function of what the BoE chooses to signal at the May policy meeting and 2Q UK economic data outturns. Should policymakers keep the prospect of a 2018 rate hike on the table this week, then we would expect signs of a 2Q rebound in UK economic activity to lift GBP/USD up towards 1.40 by end 2Q18 – with EUR/GBP resilient around 0.87-0.88 amid a recovering EUR.”