Summer is cancelled at Threadneedle Street. The Bank of England’s split over interest rates has investors hanging on the next utterances of its policymakers and the coming data. It looks like being a sweaty period for sterling and gilts.
Brexit and political stability were the UK issues holding the attention of the market but these are being overtaken by a BoE saga that has caught forex commentators by surprise.
National Australia Bank strategists say a rate rise has become “a very live topic for debate in a way in which it absolutely was not just a couple of weeks ago”. Commerzbank economist Peter Dixon, meanwhile, says it was unusual to have the BoE disagreement aired “quite so strongly in public”.
The pound has ping-ponged with each turn of the BoE debate. Investors bought sterling when three hawks voted to raise rates at the monetary policy meeting on June 15. They sold it when Mr Carney five days later said “now is not the time” to tighten. And they bought the pound again when BoE chief economist Andy Haldane disagreed with the boss the following day.
Sterling has been “given the runaround by the MPC”, says Rabobank forex strategist Jane Foley.
At stake is the reputation of Mr Carney and the bank’s credibility. A year ago, the governor and his colleagues were viewed as the only grown-ups in the post-Brexit climate of political chaos and a fast-falling currency, calming markets with contingency plans, paving the way for a rate cut in August.
So why, at a time of squeezed incomes, a hung parliament and Brexit negotiations, is the BoE debating a rate rise?
“It is an unusual combination of circumstances in which to raise rates,” says Paul Lambert, currency portfolio manager at Insight Investment.
The decision will be a finely balanced judgment. Mr Haldane summed up the BoE’s dilemma thus — keeping monetary policy too loose for too long risks higher inflation, tightening too soon and too quickly risks output and jobs.
He builds his case for tightening around, among other things, global growth, political stability (at least in Europe) and rising inflation, adding that a rate rise would still leave policy highly accommodative.
But as Kamal Sharma at Bank of America Merrill Lynch says, the UK economy is the key factor, and it has proved more durable than expected post-Brexit when the MPC cut rates.
“Despite the slowdown, Haldane still thinks UK growth is solid,” Mr Sharma says.
To Mr Lambert, the hawks’ position smacks of an attempt to correct a mistake. The BoE cut rates in August not expecting the post-Brexit economy to be so resilient and not expecting inflation to rise so quickly.
Sterling against the dollar in mid-May, against $1.26 on Friday
If so, that would be the wrong course of action. Growth is weakening, and there is little evidence of an acceleration of inflation from domestically-generated forces, he says. Inflation is coming more from sterling weakness but it is not feeding into stronger wage growth, so real incomes are being squeezed.
Markets are caught on the horns of this BoE dilemma. The pound may be catching the waves of this rates debate but, over the year, it has remained fairly rangebound against the dollar, rising over 3 per cent, and falling against the euro by the same amount.
It reached a high for the year of $1.3050 in mid-May but was below $1.26 on Friday, while the euro has gone from £0.8313 in mid-April to £0.88 on Monday.
That suggests that the pound’s job as a “shock absorber” to the post-Brexit economy, as BoE deputy governor Ben Broadbent described it, is largely done.
Not quite, says HSBC forex strategist David Bloom. He believes the pound still has further to fall. The BoE’s split opinion reflects how the hawks are focused on the economic cycle while the doves are bothered about the political uncertainty created by a weakened Conservative government.
In other words, says Mr Bloom: “Are you selling the pound on politics or buying it on cyclical issues? The market is not sure.”
Nomura is more certain. It expects the BoE to raise rates for the first time in a decade at its next meeting on August 3.
A bank that has grown more intolerant of above-target inflation creates the impression that “weaker data would now be needed to prove the case for keeping policy on hold, rather than stronger data being required to justify higher rates”, says Nomura.
Signs of an end to indecision may come in the bond market. Two-year gilt yields on Friday tipped above the overnight 0.25 per cent rate for the first time since November, as the market warmed to the prospect of a rate rise.
So the summer is set for UK market volatility. Speeches by policymakers will be closely watched with Mr Broadbent topping the list of BoE members investors want to hear from, although Mr Carney is the only scheduled speaker this week.
As for the economy, all eyes are on wage growth data on July 12 and inflation on July 18.
Brexit and parliamentary struggles will have their influences on the pound, yet many forex analysts expect the BoE battle to be the defining 2017 issue for markets.