UK Economy, Politics, Policy Rate & Sterling

Forecast: “While the BoE is very likely to keep its policy rate on hold today at 0.50% we expect the accompanying statement to further cement the likelihood of a 25bp rate hike at its May policy meeting” [FX Markets’ Nerves of Steel, 22 March 2018]

Outcome Two out of the nine MPC members voted for a 25bp rate hike at the 22 March policy meeting

Forecast “With this backdrop and likely slowdown in imported inflation, UK core and headline CPI-inflation may be close to peaking, in my view” [Bank of England – Trick rather than treat, 3 November 2017]

Outcome UK headline CPI-inflation peaked at 3.1% yoy in November 2017 and then fell to 3.0% yoy in December-January and a seven-month low of 2.7% yoy in February 2018

Forecast “At these levels, I would argue that the risks to Sterling are broadly balanced” [My Top Currency Charts,13 October 2017]

Outcome The GBP NEER continued to trade in a 3%-wide range between 13 October 2017 and mid-January 2018

Forecast “GDP growth was a paltry 0.2% qoq in Q1 2017 and macro indicators suggest it did not rise much in Q2 (preliminary data are due out on 26 July) […]. Sterling may well continue to struggle for direction with the Sterling Nominal Effective Exchange Rate (NEER) remaining in its year-to-date range. But unless the government can post some notable successes with regards to its Brexit negotiations, UK economic growth recovers or the MPC hikes rates in coming months, at the margin I see the risk biased to Sterling downside from current levels.”  [UK: Land of Hope & Glory…but mostly Confusion, 7 July 2017]

Outcome GDP growth inched up to 0.3% qoq in Q2 2017 from 0.2% qoq in Q1 based on preliminary data. The GBP NEER gradually fell between 7 July and 23 August 2017 before rising in the first half of September to levels which had prevailed around 7 July (with the GBP NEER effectively trading in a 4%-wide range).

Forecast “I am sticking to my view that a 25bp policy rate hike this year is still a low probability event and I see little chance of an August hike.” [H2 2017: Something old, something new, something revisited, 23 June 2017]

Outcome Market expectations of a summer hike rose after three MPC members voted for a 25bp hike at the June meeting but the MPC left its policy rate unchanged at its 3 August meeting.

Forecast “This would, in my view, present an opportunity to short Sterling versus the dollar or euro, for five reasons:
1. Conservative-DUP marriage is not one of choice and arguably not even one of convenience;
2. Question of which type of Brexit is unlikely to be answered any time soon;
3. MPC has become more hawkish but rate hike still unlikely near-term;
4. Concerns over falling wages are at the heart of a UK economy which remains at best soft; and
5. EU/eurozone growth slowly picking up and European nationalism on the back foot.”
[GBP – Hawkish Surprise Presents Selling Opportunity, 15 June 2017]

Outcome  Between 15 and 26 June 2017, Sterling weakened 1% versus Euro and was flat versus Dollar. The Sterling Nominal Effective Exchange Rate was down 0.6%.

Forecast “If Conservatives lose both their absolute and working majorities (a hung parliament): (1) They would attempt to form a majority coalition with one or more other parties – no easy feat as few, if any, of the other parties are likely to have both a significant number of seats and a natural affinity with the Conservatives […]. The DUP and Ulster Unionists – have given their tacit support to Brexit. They are likely to retain a combined 10 seats in the House of Commons and could conceivably side with the Conservatives in key votes. But they would not formally join a ruling coalition, their 10-seats may prove numerically insufficient and their support would likely be conditional […]. (2) Near-term risk of Conservatives holding a party-leadership election may, somewhat perversely, be more modest than in Scenarios 4-6. The reasoning is that they would be under pressure to beat Labour in forming a majority coalition government and may not want the added distraction of a leadership-election which could leave the country rudderless […]. (3) Immediate knee-jerk reaction would likely be a sharp sell-off in Sterling and jump in volatility […]. (4) A Conservative-led coalition government with a small majority would likely have to adopt a more consensual stance on policy, including Brexit, in order to partly neutralise the opposition vote and get parliament to approve policies. This may in turn help mitigate the risk of the UK walking away from EU negotiations without a deal, even if transitional, in place. At the very least it may force Theresa May to be more transparent and detailed in her presentation of policy.” [UK General Election Scenario Analysis Impact on Policy, Theresa May and Sterling, 7 June 2017]

Outcome (1) Conservatives formed alliance (but not formal coalition) with DUP which extracted a number of concessions in exchange for their support in key parliamentary votes; (2) Conservatives gave their support to Theresa May and played down possibility of another leadership contest; (3) Sterling weakened 1.5% following the election result; (4) Theresa May and government hinted it would dilute its austerity package, take a more conciliatory approach with all MPs and consider a softer line on Brexit.

Forecast  “Negotiations are due to formerly start on 19th June, according to the European Council but may only start in earnest after the German general elections on 24th September. In any case they will likely have to conclude by end-2018 to allow the British Parliament and European Council time to vote on any agreement – a negotiating timeframe of at best 18 months. This could be sufficient time for an agreement on the terms and conditions of the UK’s exit from the EU to be reached. However, by the government’s own admission, a deal on the new terms and conditions of the UK’s relationship with the EU is unlikely to be concluded within this timeframe, with a transition agreement the more likely outcome.” [When two tribes go to war, 2 June 2017]

Outcome The British government had repeatedly played down the need for a transitional agreement between the UK and EU but on 11 July David Davis said “to get the French customs in the same place in two years or the Belgian or the Dutch customs I think will be a different issue, that’s why a transition period [is needed]”. On 20 July, International Trade Secretary Liam Fox said he “did not have a problem” with the idea of an “implementation phase”, which he suggested could be around two years. Secretary of State for Environment Michael Gove said on 21 July that the “cabinet was united” over the need for an “implementation period which will ensure that we can continue to have, not just access to labour, but the economic stability and certainty which business requests”. On 26 August the opposition Labour Party formerly endorsed a transition deal that would keep the UK in Single Market and Customs Union for a number of years. By late-August, the government’s official position was one which supported a transition deal although there was still disagreement about its length and modalities.

Forecast “In a scenario of falling real earnings weighing on consumption, tepid investment growth and a broadly stable currency, I would not expect the Bank of England (BoE) to hike its policy rate from its record low of 0.25%. My core forecast is that rates will remain on hold throughout 2017 […]. I would however expect it to keep a possible rate hike firmly on the table.” [Bank of England and inflation – Sense of déjà-vu?, 24 March 2017]

Outcome The BoE kept its policy rate unchanged at its May, June and August meetings at a record low 0.25% although at the June and August meetings respectively three and two MPC members voted for a 25bp hike.

Forecast “UK retail sales in Q1 likely contracted from Q4 2016, despite their rebound in February […]. Falling real wages and soft retail sales do not bode well for consumption or GDP growth” [Bank of England and inflation – Sense of déjà-vu?, 24 March 2017]

Outcome Retail sales contracted 1.5% qoq in Q1 2017 (weakest print in 7 years) and GDP growth slowed to one-year low of 0.2% qoq.

Forecast “Nominal wage growth is struggling to keep up with inflation (resulting in slower real wage growth) which runs counter to the increasingly publicised view that the 4.8% unemployment rate points to a very tight UK labour market. Put differently, I believe that there is still slack in the labour market – with the number of those unemployed, working part-time or inactive but wanting a job still high by historical standards – which is in turn curbing workers’ ability to negotiate wages which outstrip inflation.” [Market Fatigue in the face of catastrophic success, 20 January 2017]

Outcome The UK pool of available labour had fallen only marginally to 12.16 million in February 2017 and was still 1.3 million higher than in late-2004, with real weekly earnings falling 1.5% between November 2016 and February 2017.

Forecast “If the content of Theresa May’s actual speech proves somewhat less hard-edged, Sterling and UK equities could conceivably rebound and the government claim this as proof that UK financial markets approve of her plan. It may thus be a case of […] sell Sterling ahead of the speech but buy it back once the speech has actually been delivered. Specifically, markets may take some comfort if Theresa May tomorrow shows a greater inclination for a transitional agreement once the UK has left the EU […]. The concern, however, is that Sterling’s collapse post-referendum will start feeding through more forcefully to imported inflation and consumer prices, which in turn will dent already modest real wage growth and ultimately household consumption – the UK’s main engine of growth.” [Sterling singing to (leaked) tune ahead of Theresa May speech, 16 January 2017]

Outcome Sterling weakened sharply on 16 January but GBP/USD rebounded to 1.218 in run-up to Theresa May’s speech on 17 January, which started at 11.45 (London time). GBP/USD then appreciated 0.7% during her 1-hour long speech to around 1.228 and a further 1% to just shy of 1.24 in the subsequent two hours. PM May suggested that an interim or transitional arrangement was a possibility. UK inflation jumped to 2.3% yoy in February-March 2017 from 1.2% yoy in November and real wages fell 1.5% between November 2016 and February 2017. Retail sales collapsed 1.5% in Q1 2017 – the weakest number in seven years.

Forecast “PM May will make a speech on Tuesday 17 January in which she will set out in greater details her plans for the UK’s exit from the EU. There have been few signs that she is willing to tone down her mantra of the UK regaining control over immigration in exchange for a bespoke trading deal with the EU which may exclude access to the Single Market. If Theresa May sticks to her guns next week I would expect Sterling to weaken further.” [UK inching towards Brexit, 13 January 2017]

Outcome Content of Theresa May’s speech was leaked over the weekend, seemingly confirming that the government would aim to control immigration into the UK and was willing to accept a loss of access to the EU Single Market. Sterling weakened sharply on 16 January, with GBP/USD falling to a 30 year-low of 1.196 and GBP/EUR dropping to 1.133. GBP NEER weakened to 2-month low according to my estimates.

Forecast “Hammond’s first opportunity to outline his priorities for taxes and spending following EU referendum. He will likely confirm departure from fiscal restrictions imposed by his predecessor George Osborne while re-committing to cutting fiscal deficit over medium-term (possibly 2019-2020). The likely drag on UK growth from slowing domestic consumption and investment and weaker-than-expected stamp duty receipts will limit his spending plans. Focus is likely to be on infrastructural spending rather than generous tax cuts. This could be sufficient for Sterling to rally and gilt yields to rise modestly.” [Fast and Furious – Market drift, 15 November 2016]

Outcome Hammond dropped his predecessor’s plan to run a fiscal surplus by end of parliamentary term while sticking to goal of gradually cutting deficit over next five years. There were few tax give-aways (tax take will actually increase £2.3bn) but planned increase in capital spending of £14.2bn with focus on “high-value” infrastructural investment. “Reflation-lite” likely contributed to 7bp jump in 10-year yields over 22-25 November and Sterling NEER appreciate 0.5% to a near 10-week high, according to my estimates

Forecast “This week’s fall in sterling, if anything, has reinforced my view that the Bank of England will maintain a dovish rhetoric but for now refrain from cutting its policy rate to zero or expanding its current QE program. Moreover I would not expect the BoE to intervene in the FX market to support sterling at this stage.” [Barbarians at the Sterling Gate, 7 October 2016]

Outcome BoE did not intervene in FX market following Sterling’s flash crash and has kept its policy rate and modalities of its QE program unchanged.

Forecast “The inflationary impact [of Sterling’s depreciation] has so far been very modest but the risk is a squeeze on profit margins and real wages […].Despite sterling’s 10% depreciation between November 2015 and mid-June 2016, the UK’s trade deficit on goods and services actually increased slightly […]. It is unclear whether the UK’s improved terms of trade conditions will significantly narrow the trade deficit […]. While this may not translate into another policy rate cut or round of QE near-term, the BoE is likely to keep this option firmly on the table if the UK economy fails to return to trend in the next six months.” [UK economy post-referendum – For richer but mostly for poorer, 26 August 2016]

Outcome Real wages fell in five out of seven months between July 2016 and February 2017, contracting by 1.4%, while year-on-year growth in December-February was only 0.2%. This has been a major headwind for retail sales growth which slowed to 1% qoq in Q4 2016 (from 1.6% qoq in Q3) and collapsed to a 7-year low of -1.5% qoq in Q1 2017. The UK’s trade deficit on goods and services increased to £19.6bn in H2 2016 from £17.2bn in the previous six months and £16.4bn in H2 2015. BoE has left its policy rate and modalities of its QE program unchanged since August 2016 but Governor Carney struck a dovish tone at his press conference following the BoE’s policy meeting on 3 November 2016.

Forecast “What we don’t know or can only tentatively forecast still dwarfs what we know. The referendum result simply reflected a popular preference for the UK to leave an international organisation, nothing less, nothing more. For all intents and purposes UK and EU leaders are flying blind […]. The next steps are thus anything but straightforward and the UK government and EU are currently caught in a prisoner’s dilemma, with none of the key players seemingly willing to make the first move. The referendum result is not legally-binding, only advisory, and therefore the Lower House of Parliament will likely have to vote on whether to trigger Article 50 […].Unsurprisingly, the British government is playing for time” [Post Referendum Circular Reference, 7 July 2016]

Outcome High Court and Supreme Court ruled that Parliament, not government, have legal authority to trigger Article 50. EU leaders have repeatedly made clear that they would not start officially negotiating with the UK until the British government had triggered Article 50.

Forecast “I would conclude […] that the many layers of political, legal, economic and financial uncertainty are likely to keep UK investment, consumption and employment, as well as Sterling on the back-foot for months to come. Financial market volatility is also likely to remain elevated in coming weeks.” [Brexit: More questions than answers, 28 June 2016]

Outcome Sterling collapsed post referendum, with the GBP NEER weakening 11% in the following two months. High Court and Supreme Court had to rule on the legality of the government triggering Article 50 while the government dragged its heels over the publication of a detailed roadmap for the UK. The outlook for UK economy remains uncertain at best.

Forecast “Opinions polls have concluded that a lower voter turnout today would favour the Leave vote while a higher turnout would favour the Remain vote. But intentions to vote are not the same as actually ticking the ballot box. Bad weather is more likely to keep people at home and turnout low, favouring the Leave vote while dry weather would in theory encourage people to vote, in turn favouring the Remain camp […]. Acute uncertainty and market volatility would likely persist for weeks and potentially months should the leave camp win today’s referendum, particularly if it wins by only a very narrow margin and/or turnout is low.” [UK referendum: Blame the weather, not Brussels, 23 June 2016]

Outcome Narrow victory of Leave vote led to acute uncertainty about the UK’s future economic path with UK currency and rates markets remaining volatile.

Forecast “This uncertainty, coupled with the slowdown in UK GDP growth in 2015 and opaque outlook for the Bank of England’s interest rate policy, is likely to keep sterling under pressure near-term.” [UK referendum on EU membership – Darkness before dawn, 26 February 2016]

In the following five weeks GBP NEER weakened a further 2%.

Forecast “Sterling has weakened sharply since end-November 2015 and I expect it to weaken further in coming months.” [What to expect in 2016 – Same, same but worst, 19 January 2016]

In the following five weeks GBP NEER weakened a further 3%.

Forecast There is scope for Sterling rally to extend as markets will not have to contend with a protracted period of coalition-building and uncertainty […]. However, it’s not obvious that a sterling rally will have much staying power. It is already quite expensive by historical standards and will face sterner challenges ahead, including financing large twin deficits, lukewarm macro data and omnipresent threat of a UK referendum on EU membership.” [Conservatives win landslide victory in UK elections, 8 May 2015]

In the three months following general elections, GBP Nominal Effective Exchange Rate (NEER) appreciated about 6% to multi-year high. But it then weakened about 7% between end-August 2015 and mid-January 2016 due to a record high current account deficit and financing uncertainties exacerbated by forthcoming EU referendum and slowing GDP growth.

Forecast Conservatives could perform better than suggested by opinion polls and Labour underperform, as i) in previous UK elections Conservatives outperformed when polls indicated a loss of seats and ii) the new voter registration system at the margin favours Conservatives.” [UK general elections: A riddle, wrapped in a mystery, inside an enigma, 13 March 2015]

At the 7 May 2015 general elections, the Conservative Party won a far larger-than-expected 330 seats (a clear absolute majority), while Labour (232 seats) was by far the biggest loser.

Forecast “UK Independence Party (UKIP) has been the biggest beneficiary of the loss of support for the traditional three large parties and has momentum. […] But UK’s first-past the post electoral system and constituency-boundary vagaries make it difficult to accurately translate popular support into an actual number of parliamentary seats.” [UKIP has what every political party wants … momentum, 30 November 2014]

UKIP was third largest party at 2015 general elections, with nearly 4 million (13%) votes, but this translated into only one seat in 650-seat House of Commons.