BoE will stress down­side risks de­spite mar­ket dovish

The Pak Banker - - COMPANIES/BOSS -

With short-end U.K. rates now pric­ing the pos­si­bil­ity of some Bank of Eng­land eas­ing, Gov­er­nor Mark Car­ney and the Mon­e­tary Pol­icy Com­mit­tee will walk a fine line on Thurs­day by high­light­ing down­side risks while chal­leng­ing rate path ex­pec­ta­tions two to three years ahead, econ­o­mists say. The pound faces a risk of a short squeeze this week as in­vestors have al­ready scaled back ex­pec­ta­tions for the tim­ing of a rate in­crease, an­a­lysts say. The BOE rate de­ci­sion, min­utes and In­fla­tion Re­port are due on Thurs­day at 12pm U.K. time while the press con­fer­ence is sched­uled to start 30 min­utes later.

Ex­pect 8-1 vote for rates to re­main at 0.5 per­cent. The near-term in­fla­tion pro­jec­tion will be lower than at the time of the Novem­ber In­fla­tion Re­port, but the fore­cast for 3 years hence will be above 2 per­cent. That would in­di­cate the curve is too flat, which may be seen as rel­a­tively "hawk­ish" by cen­tral bank watch­ers.

The over­all tone will be that a neart­erm rate in­crease is off the agenda, con­sis­tent with a pos­si­ble late-2016 or even early 2017 rate rise. This would be a dovish shift rel­a­tive to Novem­ber's up­date, but in line with JPMor­gan's view that the cen­tral bank will lift rates in the fourth quar­ter of 2016.

Gold­man Sachs (An­drew Ben­ito) fore­cast 8-1 vote for rates to re­main at 0.5 per­cent. Ex­pect fore­casts for in­fla­tion in 2 years to be marginally higher than in Novem­ber, while the 3-year es­ti­mate will be fur­ther above tar­get. The MPC will prob­a­bly say it wishes to avoid such an over­shoot. That will, how­ever, be mod­er­ated by com­ments about the down­side risks, which will some­what en­dorse mar­ket pric­ing.

The big­gest chal­lenge to Gold­man Sachs's view is if the MPC sees low in­fla­tion as a sig­nif­i­cant risk to the an­chor­ing of in­fla­tion ex­pec­ta­tions. BofAML Ka­mal Sharma, Robert Wood, Se­bastien Cross said wages, oil and down­side growth risks give BOE plenty of rea­sons to wait be­fore lift­ing rates. Ex­pect the In­fla­tion Re­port to give a more dovish view of the rate out­look than in Novem­ber.

Even so, re­cent speeches by MPC mem­bers have not been as dovish as mar­ket ex­pec­ta­tions and it's hard to imag­ine of­fi­cials will fully en­dorse the cur­rent flat­ness of the curve. Look for a mean in­fla­tion fore­cast of 2 per­cent at the 2-year hori­zon and 2.2 per­cent at the 3-year hori­zon. UBS David Tins­ley says the MPC's fore­casts will con­tinue to qui­etly im­ply that the mar­ket isn't pric­ing enough tight­en­ing, but it isn't yet time to turn up the vol­ume given the broader mar­ket volatili- ty, softer GDP Novem­ber's re­port.

Ex­pect MPC fore­casts for in­fla­tion in 2 years and 3 years to be sim­i­lar to those in the Novem­ber re­port. The MPC would be re­luc­tant to push hard against mar­ket rate ex­pec­ta­tions given the down­side risks, and such a push back isn't worth­while as the ref­er­en­dum on EU mem­ber­ship looms. Deutsche Bank Jack Di Lizia says the front-end of the curve is pric­ing a rate cut, set­ting a high bar for Car­ney to out-dove the mar­ket, so any hawk­ish nu­ance could spur some re­trace­ment.

Any ac­knowl­edg­ment of the off­set­ting im­pact of a weaker pound on in­fla­tion's tra­jec­tory could be seen as hawk­ish rel­a­tive to mar­ket pric­ing, and rate-cut ex­pec­ta­tions may be vul­ner­a­ble if Car­ney stresses the up­ward tra­jec­tory of the rate path. A 0.3 per­cent to 0.4 per­cent down­grade for 2016 in­fla­tion is pos­si­ble, but ster­ling's de­pre­ci­a­tion and steeper oil curves sug­gest fore­casts for 2017 and be­yond should be more in line with those in Novem­ber.

RBS Ross Walker ex­pect a unan­i­mous vote, with McCaf­ferty drop­ping his dis­sent as he did in Jan­uary 2015, when the back­drop was quite sim­i­lar. The three hur­dles to a rate rise, as iden­ti­fied by Gov­er­nor Car­ney, are nowhere close to be­ing achieved.

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