GBP - betting on a rate hike? - Rabobank

"Central bank watching is often not about what economists believe policymakers should do but what they could do. The latest Bloomberg survey suggests that more than three quarters of analysts now expect the BoE to raise rates at its November meeting, up from around one in five last month," Rabobank analysts pointed out.

Key quotes:

"This change in view is unlikely to be built upon revised expectations about the resilience of the UK economy but upon the apparent determination by Governor Carney and other BoE policymakers “to make some modest adjustment to interest rates”."

"We have previously argued that the Bank’s turn towards more hawkish rhetoric in September was centred on providing support for the pound. The MPC can claim some success. CFTC data show that speculators net GBP positions turned positive at the end of September for the first time since November 2015.  As rate hike bets took hold, sterling became the best performing G10 currency in September before political uncertainty set the pound on a rocky ride at the start of October." 

"There is a fairly straightforward link between the exchange rate and inflation which could explain why the BoE is prepared to pull out the stops to try and stabilise the pound. Due largely to last year’s post referendum induced drop in the pound, UK CPI inflation has spiked to 3.0% y/y in September, well above the Bank’s 2.0% y/y inflation target.  Potentially more worrying are that signs of second order or domestically generated inflation pressures have started to emerge.  This could leave a painful legacy on the UK economy if allowed to develop further.  This factor is most likely to be the most powerful in persuading the doves on the committee to vote for a hike next month.  The doves will be aware of the widely publicised argument that the current vulnerability of the UK economy suggest that a rate hike is not appropriate.  Inflation has eaten into real incomes and reduced consumers’ purchasing power.  The Office of National Statistics this morning indicated that the 3.1% y/y rise in food inflation in September was the highest since October 2013."

"More hawkish members of the committee are likely to argue that the risks that the BoE foresaw for the economy last summer did not manifest – at least not then. More recently there have been signs that the UK economy, which is exposed to the whims of international investors due to its large current account deficit, could find it more difficult to attract investment. However, arguably a more stable pound which enhance the UK’s credibility in the eye of investors."

"The ONS recently announced a large downward to the UK’s net international investment positions which indicates that the UK owns far fewer foreign assets and owes more to foreign investors than previously thought. Political uncertainly suggests that the UK’s generally strong position as a home to inward investment is being compromised.  This implies downside potential for the pound.  Although doves could argue that a weaker pound would boost exports and cushion the economy, the damage done to the economy by a period of sustained inflation could more than counter the positive effects." 

"On the assumption that the doves at the MPC have been persuaded that a rate hike is necessary to head off further inflation risks, the next question is whether a 25 bp rate hike will be successful in achieving a more stable exchange rate. As we pointed out above, the BoE have had some success in stabilising the pound.  However, it is our view that due to a slowing economy the Bank will not be able to follow up a near-term hike with another move for some time.  This factor combined will political risks suggests that GBP remains vulnerable.  We expect a move towards EUR/GBP 0.95 on a 12 mth view."