Article / 06 November 2015 at 12:32 GMT

Not-so-lonesome doves

Head of Trading / The ECU Group plc
United Kingdom

  • BoE statement delays normalisation effort
  • Policy divergence will continue to support GBP
  • Today's NFP print crucial for data-dependent Fed

Bank of England

Yesterday's ultra-dovish bank of England statement doesn't change the divergence narrative between the GBP and the 'easing currencies'. Photo: iStock

By Neil Staines

Hindsight bias makes surprises vanish — Daniel Kahneman

Earlier this year, we argued for the start of monetary normalisation from the Fed in September followed promptly by the Bank of England in November. However, the global... audibility of the turmoil in Chinese stocks and a surprise currency devaluation brought the troubles of the emerging world to the fore and dented confidence in the global recovery.

Moreover, as the September Federal Open Market Committee meeting approached, the US data had shown signs of slowing in Q3'15 and the concern that the US recovery would be dragged down by the faltering global economy grew. 

The big question now is whether the "slowdown" in Q3 was a bump in the road, or a pothole that damaged confidence, consumption, investment and thus the recovery. 

This afternoon’s US employment report for the month of October is thus very significant in its implications for the trajectory of the US economic recovery, US rates and the USD.

Everyone’s quick to blame the alien” — Aeschylus

It is perhaps surprising that most global central banks have, at their most recent gatherings, pointed to their respective domestic strengths while almost all have also pointed to external, or international risks. In part, this can be explained through the transition away from manufacturing and global trade by China (and to a lesser extent Germany) and the disproportionate negative connotations for commodity exporter nations that have fed off this industrial expansion.

A brief glance around the major central banks at the moment, while offering little action, highlights a clear differentiator in terms of policy bias. While the European Central Bank, the Swiss National Bank, the Reserve Banks of Australia and New Zealand, the Riksbank, the Norges Bank, and the People's Bank of China have all stated and reiterated a clear easing bias, the Fed and the BoE have the opposite.

BoE report highlights global weakness, domestic strength” — Nemat Shafik

Yesterday, it was the Old Lady of Threadneedle Street's turn to be placed under the monetary microscope. The response of the market (and many commentators) was that the inflation report (and its accompanying press conference) was singularly dovish. 

From our perspective, however, we would argue that while the modest downward revisions to the growth and inflation forecast warrant a near term adjustment (down) in GBP and (lower) in rates, such weakness provides a medium-term opportunity. 

Particularly, in the FX space, against a currency where the respective central bank has an explicit easing bias.  

The Monetary Policy Committee increased the emphasis of the pass-through effects on inflation from the strength of the pound, with the downward drag from the currency to core inflation judged to be persistent and stronger than previously estimated. 

However, the MPC also judged that economic slack has fallen to just 0.5% and that while “UK growth has ticked down to around trend rate... private domestic demand remains resilient”. Furthermore, with tighter labour market conditions and higher wage growth than the US, the recent divergence between US and UK rate expectations are not sustainable in our opinion. 

As the UK unemployment rate pushes ever closer to its long-run equilibrium, we would envisage that higher wage and broadening inflation pressures (particularly when the base effects of last years oil price collapse fall out of the comparison around the turn of the year) will boost rate expectations, inflation expectations, and the GBP.

Ultimately we retain our long-held positive view of GBP and the USD against those currencies whose central banks have an easing bias. Against the current global backdrop we continue to favour USD and GBP longs against EUR as the recent string of very weak German data continue to stoke expectations of further far-reaching policy easing from the ECB in December. 

For today though, it is the US and the relative strength of the October employment report that will dominate the proceedings.  

This afternoon sees the rate-hike narrative travel back across the Atlantic... Photo: iStock

— Edited by Michael McKenna

Neil Staines is head of trading at The ECU Group


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