Subdued Inflation Sees the BOE on Hold for Longer

Given the UK's return to deflation and dip in Core CPI back to 1%, combined with dovish MPC minutes, we

After rallying substantially against almost every counterpart during the best part of 2015, the sterling began to exhibit weakness around August as persistently low inflation and volatility in financial markets caused expectations of a rate hike to be pushed further out into 2016.

The BOE still intends to raise rates in 2016, however the approximate month in which this will occur has been moving further towards the end of the year, whereas previously it was expected in the first or second quarter. This adjustment in rate hike timing has precipitated a repricing of the sterling exchange rate, and as such GBP has seen weakness across the board in recent months. 

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Inflation

The key metric holding the BOE back from raising rates is very low inflation. CPI readings for September, released on October 13, showed deflation in the UK with both the m/m and y/y coming in below expectations at -0.1%. This subdued headline inflation was expected by the BOE as illustrated in their Quarterly Inflation Report forecasts.

Headline inflation is severely impacted by the decline in the oil price, and is outside of the control of the BOE’s monetary policy. More concerning for the BOE is the decline in Core CPI which for September also missed estimates and dropped to 1% y/y and a 0.1% for the month. This miss on CPI saw GBP sold off across the board as low inflation looks to keep MPC members from voting for a rate hike in the near term. 

In contrast to the inflation situation, UK employment has been excellent. The most recent jobs report, released on October 14, saw Average Earnings move up to 3%, not far from the 3.3% level printed in May, which is the highest rate of wage growth since 2010. The BOE are focused on wage growth because increases in wages translates into more disposable income for consumers whose spending helps to push inflation back up towards the 2% target.

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In addition to the solid wage inflation, the unemployment rate ticked down to 5.4% which is the lowest level of unemployment since the global financial crisis. Although the Claimant Count Change missed estimates, showing that 4,600 people joined unemployment benefits in September, versus the expectation of 1,200 leaving, the market focused on the positive unemployment rate and wage growth; GBP rallied across the board with Cable moving up 300 pips from the prior day’s post-CPI lows. 

Monetary Policy Committee

On October 8, the MPC released their Monetary Policy Summary and the minutes from their October 5-6 meeting. The minutes showed the MPC voted 8-1 to leave the Official Bank Rate on hold at 0.5%. Again, McCafferty was the lone dissenter calling for a hike now.

Overall, the minutes and MP summary were dovish, stating that near-term inflation expectations remain subdued and that CPI is forecast to remain low well into next year, longer than previously anticipated in the QIR forecasts. The minutes weighed on the pound and have prompted a further readjustment of rate hike expectations.

The BOE still plans to hike rates in 2016, which gives the currency strength fundamentally, however, just as with the Fed, the BOE cannot hike rates until they see inflation moving higher, towards the 2% target. Until this occurs, rate hikes will continue to be delayed.

Given the UK’s return to deflation and dip in Core CPI back to 1%, combined with the dovish MPC minutes, we see GBP as a weak bullish currency rather than a wholly bullish one. This will remain the case until we see a noticeable move higher in CPI.  

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