Less than a month after voting to leave the European Union, the U.K. now has a new Prime Minister and a new cabinet. While this change was faster than markets’ expectations, the question remains - will the BoE move at the same speed?
The Bank of England will hold a policy meeting today, with market expectations high towards the easing of monetary policy through cutting rates by 25 basis points. However, the gains in the pound today reflect some concerns that the central bank will not act at this meeting and will instead wait until August, when it will become clearer to what extent Brexit will impact the economy, and what fiscal policies might be seen under the new Chancellor, Philip Hammond.
Possible Scenarios
Markets are already pricing in a 25-basis-point rate cut at this meeting, so leaving rates unchanged will lead to a strong recovery in sterling towards 1.33 – 1.34. However, a rally could be seen as a good opportunity for traders who missed shorting the currency when it dropped by more than 2000 pips post the Brexit vote, as more turmoil is expected to come.
Cutting rates by 0.25% and leaving other monetary tools unchanged is likely to have a slightly negative impact on the pound. Traders will then move to ask what’s next, hoping to get more guidance from Governor Mark Carney, who already announced that economic outlook has deteriorated and that some monetary policy easing will likely be required.
Although unlikely at this meeting, restarting the quantitative easing program, which currently stands at £375 billion, could be on the table, and a combination of a rate cut along with a new QE program has the potential to pull back GBP/USD below 1.3.
An additional measure to boost bank lending to households and companies is through restarting the funding for lending scheme program which kicked off at August 2012. But this step is also unlikely, especially after the BoE freed up to £150bn worth of lending by relaxing regulatory requirements on the banking sector.
I believe the most likely scenario is for Mark Carney to meet the markets’ expectations through cutting rates by 0.25% while leaving some bullets for August when the inflation report is released. His priorities now are to stabilize the exchange rate and to avoid the U.K.’s economy entering a recession.
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