Special FX Report – BOE may pause QE at Thursday’s meeting
Tuesday, February 2nd, 2010The Bank of England (BOE) will hold a monetary policy meeting on Thursday, February 4th. The BOE is widely expected to hold rate policy unchanged at 0.5%. It is less clear whether the BOE will elect a pause in its asset purchase plan and quantitative ease. The shadow MPC members were split on the outlook for BOE policy. Two members of the shadow MPC want the BOE to raise interest rates 50 bps to 1%, four members want to expand asset purchases and three are calling for a pause. Recent UK economic data has been mixed but on balance the reports suggest that the pace of the UK recovery will become of less concern for the BOE. Monday, the UK reported that manufacturing sector PMI rose to 15 year high. The rise in the manufacturing PMI reflects a surge in exports. UK Q4 GDP confirms that the UK economy has emerged from recession but the report came in weaker than expected rising just 0.1%. UK housing prices are improving along with a modest uptick in retail demand. UK January housing prices rose at the fastest pace in five months but December retail sales were reported up a modest 0.3%. UK inflation is also rising. December CPI rose by 2.9%. This puts UK annual inflation rate near the high end of the BOE’s inflation target. Weak GBP contributes to rising inflation pressures. The rise in UK CPI may encourage the BOE to pause its asset purchase plan. The BOE’s Sentance said that the central bank may have to consider raising rates sometime this year. One troubling piece of data for the BOE is Monday’s report that M4 money supply contracted in December.  The contraction in the money supply suggests that BOE asset purchase plan is having limited impact on boosting money supply growth. This means that the UK may face a weak recovery as liquidity conditions remain tight.
Over the past few weeks the GBP has been outperforming supported by speculation that the BOE is moving closer to a pause in its asset purchase plan. GBP has also been supported by a statement from the UK Chancellor Darling that the UK has plans to halve its deficits over the next four years. The UK AAA sovereign debt rating is at risk for downgrade if the UK government fails to take action to reduce its deficit. The outlook for the UK deficit is clouded by election uncertainty. The UK is expected to hold a general election on May 6th. Recent election polls suggest that there is a risk the election results in a hung (gridlocked) parliament. UK election polls released over the weekend show that there is increased possibility of a hung parliament with a survey by the Independent released Tuesday which states that the Tories will fall 24 seats short of an overall majority in parliament. A lack of majority and a hung parliament will make it more difficult for the UK to protect its AAA credit rating. The uncertain outlook for the UK budget presents an additional challenge for the BOE. If the UK election increases the chance the government will take action to reduce its deficit it may contribute to a slower UK recovery as stimulus is withdrawn.
GBP drifted lower to start the week as investors return focus to uncertain outlook for UK economy. Report of a drop in mortgage approvals revives concern about the strength of the UK recovery. GBP will likely experience a modest rally if the BOE elects pause in its asset purchase plan. If the BOE leaves the door open for future expansion of asset purchases the GBP is likely to return to its underperformance. According to Bloomberg news the BOE may pause its bond purchase plan as BOE officials balance the impact of rising inflation against risk of weak economic recovery. In response to building inflation pressures the BOE may incorporate more hawkish language in its policy statement.
Written by Easy-Forex
