Who Will Pull The Trigger First: The BoE Or The Fed?

Federal Reserve officials have been sending out mixed signals regarding the timing and the pace of monetary policy normalisation in the US. Meanwhile, the BoE officials remain in wait-and-see mode even as the Conservative government officially starts its second term. The Fed and the BoE are expected to be the first central banks to proceed with monetary policy normalisation; with Fed seen to leading the move. Nevertheless, the BoE’s hawkish potential appears be under-priced.

The BoE has stayed static over the past few months waiting for the outcome of the UK general election while the Fed moved significantly dovish during the same period. Not only have the expectations for the first Fed hike postponed from June to the end of the year – and even to the beginning of next year, but also the anticipated pace of the rate normalisation has been halved.

Following the outright Conservative victory, UK PM Cameron’s promises to further reduce government’s budget deficit, which has already declined from above 10% to 5.4% of the GDP during his first five years in power, have become reality. With 30 billion pound worth of austerity package on the agenda, the Bank of England is now put to a position where it should prevent the fiscal tightening from interfering with the already fragile economic recovery. The Bank of England is therefore believed to be sitting on the extreme dovish end of its monetary policy and the lack of early achievement on the fiscal edge could only pull the BoE toward more hawkish territories.

Looking at the economic data, the growth figures give more optimistic signals in the UK than in the US. The UK’s gross domestic product expanded 0.3% in the first quarter, while the US is seen dangling near the precipice of negative growth. Due on Friday, contraction of 0.8% on quarter (annualized) is the consensus for the US’ first quarter GDP estimate. A quick glance to Citi’s surprise index suggests that the economic data has been less disappointing in the UK since June 2014 then in the US. In this context, the market might be under-pricing the UK recovery.

Who, between the Fed and the BoE, will be the first to tighten the policy is still unknown. The sovereign curves have steepened both in the UK and in the US over the past month. Although the US sovereigns are subject to higher volatilities, it should not be taken for granted that the Fed will be the first to act. In fact, a symbolic first hike could be on the BoE’s agenda, given that the UK central bank may now reset the tone by surprising the market, not merely to start tightening but rather to highlight a certain level of independency after having remained under the shadow of domestic and external politics over the past months.

A symbolic BoE move, if any, would be appropriate in November, in line with former rate hike expectations. If this scenario materializes, the BoE would have made the first step given that the market is only pricing in a 25% probability of the Fed pulling the trigger in September.