The Bank of England (BoE) cut the bank rate by 25 basis points as expected, yet surprised investors by expanding its sovereign bond purchases target by £60 billion to £435 billion and by announcing an additional £10 billion worth of budget in corporate bond purchases. By doing so, the BoE has officially taken the same path than its nearest neighbour, the European Central Bank.
As a knee-jerk reaction, the Gilt yields took a dive. Investors rushed into the UK’s sovereign markets betting on solid, and almost guaranteed gains in capital. The back-end of the yield curve suffered a higher downside shift. The 10-year Gilt yields plunged to historical lows.
On the back of our recent experience, we could predict that the decline in the UK yields has only just started. A deeper plunge in yields is on the horizon as the BoE committed to tap into the sovereign and the corporate bond market to sustain the UK’s fragile business outlook post-Brexit.
A further cut in the bank rate is also a possibility. Nevertheless, the probability of a second rate cut has declined significantly as the BoE's Governor Mark Carney insisted that the lower bound should expected to “be close to, but a little above, zero.
As of today, the market gives less than a 40% chance for an additional 25 basis points cut by the end of 2016. However, we could well expect a smaller cut of 10-15 basis points, should the BoE want to make sure that the monetary conditions have become sufficiently loose to avoid any stress in the financial place.
In the FX markets, the sell-off in sterling remained reasonable. Cable saw support at 1.31, while the euro-pound came off after hitting a three-week high, 0.86225.
FTSE rallied by more than 150p on Thursday and the rallied continued at the open on Friday. Stock investors are buying into the central bank’s efforts to support the financial conditions in order to provide a suitable base for a smoother structural transition in the UK’s business environment.
Financials outperformed yesterday’s session, as perhaps the additional £70 billion worth of sovereign and corporate bond purchases was thought to give a positive push in terms of trading activity. Yet the operating margins in the banking sector will be further squeezed as the UK rates are now set to move toward, but not below, zero.
RBS (LON:RBS) (-5.68%) second quarter net loss £1.08 billion vs. £280 million profit in 2015.
Energy stocks are also taking a breather as the price of a barrel of WTI shows signs of stabilisation above the $40 level after having plunged to $39.25 earlier in the week. Royal Dutch Shell (LON:RDSa) (+0.71%), BP (LON:BP) (+0.44%)
US jobs data
Finally, the US jobs data is the last big event of the week. The market expects a further improvement in the US unemployment rate, with ideally, better wages growth. The consensus for nonfarm payrolls is 180,000. A strong jobs read in the US could bring the Fed hawks back to the market.
We expect a two-sided price volatility in the US stock markets before the weekly closing bell. A strong US jobs read should improve the risk appetite and push the US stocks higher.
However, a good print would also revive the Fed rate hike expectations and trigger a rally in the USD, hence could jeopardise the appetite in the S&P and the Dow stocks. Offers abound at 2200 and 18600 respectively.