QIR preview – Balancing act for BOE ahead of referendum

١١ مايو ٢٠١٦

Bank of England (BOE) will be in the spotlight tomorrow as it is scheduled to publish its quarterly inflation report (QIR) along with interest rate decision and minutes. Carney’s comments at the presser too would hog the limelight. It is going to be a balancing act for BOE as EU referendum (at June 23rd) is just five weeks away.

• Brexit bets have dropped off late, however, corporate continue to hedge against the risk of a sharp drop in Pound in case ‘exit’ vote wins.
  

• Oil is up 65% from its bottom in January. Prices have strengthened almost 30% since last QIR release on Feb 4.
  

• November 4 QIR event saw BOE ditch hawkish tone and adopt a dovish tone. From then on till date, GBP/USD is down 7% (partly due to Brexit fears) and the EUR/GBP is up 12%.
  

• Risk sentiment in the financial markets has stabilized, tracking the rally in oil prices.
  

• UK economic data has worsened – UK Q1 current account deficit hit eight-year high, PMI indices released last week showed contraction in manufacturing activity and slowdown in service sector, Sharp slowdown in GDP is expected, Labor market is showing signs of weakness, Consumer confidence is at 2-year low.
  

• BOE rate hike not seen happening before 2019, while markets put the probability of a rate cut in 2016 at 40%.
  

• BOE rate hike not seen happening before 2019, while markets put the probability of a rate cut in 2016 at 40%.
  

• Fed rate hike bets have dropped sharply – Markets do not see rate hike happening before Nov/Dec 2016.
  

We expect –

• BOE to avoid explicitly taking sides in Brexit debate, but subtly warn about negative effects of Brexit like – drop in business confidence, sharp sell-off in Pound.
  

• Interest rate vote count likely to stay unchanged at 9-0. A significant minority expects one or two policymakers in favor of interest rate cut. However, this would be equivalent of taking ‘pro Brexit stance’ and may lead to sharp sell-off in Pound.
  

• Note the referendum is still five week away and a lot can change by then (in polls). Hence, setting Pound on a downtrend is something the BOE would try to avoid.
  

• Given the depreciation in Pound and a sharp rally in oil prices, there is little reason for BOE to sound worried about inflation. However, that is a well-known fact and thus upbeat comments on inflation would be good news, but may not result in a sharp rally in Pound.
  

• Weak economic data is a well known fact as well and hence downward revisions to growth forecasts would not be a surprise as well. Bank is likely to stress that Brexit could lead to serious drop in GDP.
  

• Bank is likely to reiterate the next move in rates is likely to be higher, but is in no hurry to move rates and stands ready to cut rates if required.
  

Impact on Sterling is likely to be limited unless there is an explicit hawkish/dovish surprise. If we look at GBP/USD chart, odds of a bullish move appear high.

GBP/USD Weekly chart

• Repeated failure to stay below 1.44 levels despite weak economic data releases in the UK last week has increased odds of a move higher towards 1.45-1.4549 levels.
  

• On weekly chart, we also see a bullish 5-MA and 10-MA crossover and a recovery back above 5-MA.
  Area between 1.4668-1.4770 is likely to be dominated by offers.
  

• On the downside, a break below 1.4362 preferably on daily closing basis would be a signal that a temporary top is in place at 1.4770. In such a case, support at 1.4235 stands exposed.
  

EUR/GBP – Possible Head and Shoulder on daily
Food for thought – Given, price action on charts usually serve advance warning of what is to come… the hint of a head and sh