November 2016, BoE Rate Decision Preview

All eyes turn to the Bank of England rate setting meeting today as investors expect to hear policy decisions from the Old lady of Threadneedle.

For one, it is quite clear that a rate cut is no longer on the agenda after the central bank pushed interest rates 25bps lower during its meeting in October. Thanks to renewed Brexit trade talks and the uncertainty surrounding how Britain will chart its way out of the EU, the pound sterling saw strong selling while pushing inflation higher.

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UK Inflation rate m/m: 1.0%, September 2016

According to latest inflation report released by the ONS earlier in October, data showed that consumer prices in the UK rose by 1.0% in the year to September 2016, marking the highest since November 2014. With the continued plunge in the sterling’s exchange rate, businesses will likely take time to adjust to the new pricing, which could mean that further inflationary pressures are likely to come over the coming months.

At its previous meeting in September, the central bank conveyed that it would undertake a re-assessment of the UK’s economy to consider the future course of action. While leaving policy steady, the BoE has back in September left the door option for another interest rate cut, which could effectively bring the UK interest rate closer to zero percent. The decision was unanimous in keeping the bank rate at 0.25%, corporate bond purchases steady up to £10 billion and government bond purchases at £435 billion.

GBP rallies on BoE Gov. Carney’s comments

Last week, Bank of England Governor Mark Carney in a testimony to the House of Lords spoke on the economic consequences of the Brexit vote. He said that the sterling’s exchange rate is something that the central bank would take into account at its next policy meeting (today).

In his speech, Carney said, “We are not a targetter of the exchange rate, we target inflation, but we are not indifferent to the level of the exchange rate. We have seen in recent weeks a fairly substantial shift in the exchange rate.”

The BoE Governor said that inflation could rise to 1.5% – 1.8% by spring of 2017. He also spoke briefly on the central bank’s QE policies saying that “we are mindful of the side effects of quantitative easing” and that “the BoE will now slavishly rely on QE if more stimulus [was] needed.”

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GBPUSD Price chart: 1.2185

Carney also said that the current perception of the markets as far as the UK was concerned could be misplaced. “That perception… influences a perception of where the supply potential of this economy will be in the next few years… that perception may well be mistaken,” Carney said in reference to the Brexit talks and the current uncertainty surrounding the issue.

Risks of stagflation increases

While higher inflation would be a welcome sign, it also increases the risks of stagflation. Stagflation is defined at high inflation combined with stagnant demand and high unemployment. The UK’s economy is significantly away from stagflation but there are risks no doubt. Last week saw the release of the third quarter preliminary GDP report which surprised economists. Beating estimates of 0.3%, the GDP in the UK rose 0.5% for the full quarter after the June Brexit referendum. The GDP report also showed an annual GDP growth rate of 2.3%, which was higher compared to a year ago.

Although the GDP data has been relatively better considering the political landscape, the risks of stagflation remain a primary concern for BoE officials as they meet today. While interest rates are expected to remain unchanged, there is scope for QE to be unchanged at today’s meeting. The BoE could most likely kick the can down to the December meeting when further economic data, especially after the recent plunge in the GBP will be considered before making further policy decisions.