GBP: A BoE ‘goldilocks job’ today will be neutral-mildly bullish - ING

Analysts at ING suggest that it's all about the Feb 'Super Thursday' BoE meeting today, though before getting into the nuances of what to expect – they thought it may be useful to outline what they see as 4 misconceptions in GBP markets right now.

Key Quotes

“Misconception 1: GBP requires a summer Bank of England rate hike to rally. Not necessarily. For currencies, we continue to be believe that it is the overall level of policy tightening priced into markets that matters more and this is certainly true for GBP crosses – which exhibit the greatest sensitivity to relative interest rate differentials across the 2-5 year part of the curve. This means that positive surprises in the UK economic cycle and Brexit progress – both of which can affect the extent to which the BoE will tighten policy in this normalisation cycle – matters more for GBP than the actual timing of Bank rate hikes. With only 65bps (less than 3 hikes) worth of implied BoE tightening priced into the 2-year part of the UK rate curve, we think that there is scope for some upside here on any ‘good’ UK news over the coming months.”

“Misconception 2: GBP’s rally this year has been reflecting optimism over a ‘soft’ Brexit. Sure, while we agree that there has been a positive re-assessment of the Brexit tail risks since last December’s Divorce Deal – we shouldn’t get carried away at overstating this effect on recent currency moves. GBP/USD’s rally above 1.40 earlier this year had little to do with anything GBP-specific; we point to the fact that the 6-month correlation between GBP/USD and EUR/USD picking up to its highest since the Brexit referendum (~0.55) – which suggests that this has predominantly been a weak USD story (and therefore little evidence to cite GBP’s rally as being Brexit or UK-specific). If anything, the reduction in Brexit tail risks has merely allowed GBP/USD upside to participate in a broad weak USD environment.”

“Misconception 3: Markets are long GBP and so the scope for upside is limited if any GBP-specific catalyst kicks in. The latest CFTC speculative positioning data puts GBP/USD net long positioning at 14% (of open interest)- which is the highest since 3Q14. Yet, seeing a similar pattern for EUR/USD, suggests that this may not necessarily be GBP-specific. Looking more broadly, and including real money flows, we point to the UK’s basic balance – and decline in the financial account (namely portfolio and FDI net inflows) as evidence of slowing demand for GBP-assets over 2017. One would expect this to reverse in 2018 should the UK economy stay resilient and an orderly Brexit transpire. So we still believe the broader market remains structurally short GBP – but to get any meaningful shift to more neutral GBP positioning levels, investors will need to see a fundamental UK economic story emerge.”

“Misconception 4: GBP strength would slow down the Bank of England’s need to hike. The inflationary damage is already done from GBP’s sharp post-referendum deprecation. Moreover, on a trade-weighted basis, GBP still remains 8-10% below its pre-referendum levels (remember GBP’s rally has been largely all against the US dollar). Given the size of the shock – and ongoing uncertainty – it may be that the pass-through effects of GBP's post-Brexit depreciation turn out to be less transitory – and more persistent – than originally thought. Given the Bank’s growth-inflation trade-off, a gradual normalisation cycle and slightly stronger GBP is unlikely to derail UK economic growth (especially if the domestic side remains resilient) – but will help to keep price pressures in check. We may see evidence of this shifting trade-off at today’s BoE policy meeting.”