UK Autumn Budget 2021 preview: What to watch this week

Chancellor Rishi Sunak presents his Autumn Budget this Wednesday. We profile some of the big issues to watch out for this October in this budget preview.

UK budget preview

The UK’s economic health

The budget is a time to reflect on where the UK has gone, economically, and where it’s going. Chancellor Sunak will be on hand to let us know the headline stats regarding employment, GDP growth, and inflation.

We know the UK economic recovery is also beginning to slow. Supply chain issues, rising unemployment in some industries, such as hospitality, and rising inflation, are all conspiring to inhibit growth.

The GDP has dropped 10% since the start of the pandemic. Bank of England forecasts suggest 2% growth in Q3 2021. Consumer price inflation stands at 4.5%.

This will fit into Sunak’s thinking and planning.

„Inflation, interest rates – those are two of the factors which I have to think about as I determine what’s the appropriate fiscal policy, what’s the right level of tax and borrowing and spending,” Sunak told the Radio Times in a recent interview.

The Office of Budget Responsibility is thought to be preparing GDP growth figures outstripping its 4% rebound shared in March. Whether this is true or not remains to be seen.

Blonde Money CEO and macroeconomics guru Helen Thomas has shared here thoughts on what could be a „Halloween horror show“ for the UK this autumn:

How will the pound perform this budget?

Forex traders and general economic observers will be interested to see where sterling goes from here.

At the time of writing, GBP/USD was floating around the 1.375 level. Resistance was formed around 1.385.

Watch for where the pound goes. A strong budget could strengthen sterling against other currencies, but one that shows slumping economic growth may cause it to fall.

Taxes, taxes, taxes

With record levels of borrowing, in excess of £320bn, to keep the country running in light of the pandemic, the real question is who is going to pay for it?

The answer could be more personal taxes. Chancellor Sunak has already increased National Insurance, with contributions increasing by 1.25% from April 2022 onwards. It’s unlikely this will be enough to foot the government’s pandemic-led spending.

We could be about to see more higher levels of personal tax. There has been talk of an online sales tax percolating for a while now. It might not come this Wednesday, but it could be that the Autumn budget gets the ball rolling in this area.

There have also been calls from sectors to raise inheritance and capital gains tax too. The tax on dividends is probably going up to 1.25% too. Sunak may become the most tax-happy Chancellor in post-war Britain, but I guess extreme circumstances call for extreme measures.

Unless you’re a bank. KMPG has said it understands that Sunak will be dropping the Bank Levy from 8% to 3% by 2023. It’s a move to keep the City competitive in light of Brexit.

Although with rising fuel costs, one mooted plan to protect consumers would be a dropping of VAT on household energy bills.

That said, the government also has a green agenda to pursue. If it wants the UK to go net-zero by the middle of the century, then grants, loans, and so on will need to be put in place. How else can the government level up its green credentials? It’s estimated that the UK will lose £37bn in fuel duties every year if/when petrol-powered cars leave the roads.

Spending and borrowing

The conclusion to the UK’s 2021 Spending Review will coincide with this week’s budget too.

The Chancellor has had a lot to review. All of the UK’s support and spending programmes that originated during the Pandemic will no doubt be under the magnifying glass.

With GBP 68bn in Covid spending planned for 2021/22, the Chancellor has left little to no allowance for pandemic spending next fiscal year. COVID has not gone anywhere. In fact, it may be starting to ramp up again in the UK as the winter months roll in.

If Sunak has not left any spare cash available to anticipate a rise in COVID-19 cases, then that seems irresponsible. He may have to find some from the Spending Review or from the extra taxes and levies we discussed earlier.

There’s also the question of green spending. In order to reach that mythical net-zero status by 2050, the UK will have to spend at least £55bn a year. That means sustained solid investment in renewable energy projects and other things like proper house insulation and boiler replacement.

COP26 is looming so perhaps we’ll see more money allocated to green projects as a way of paying lip service to the UK’s climate goals.

But where there is spending there must also be cuts.

Sunak tasked all government departments to find 5% in savings going forward under this 2021/22 Spending Review.

“The scale of efficiency savings will be of immense interest when looking at the potential scale of fiscal consolidation over the next few years,” KPMG said in its Autumn Budget preview.

Will the Bank of England actually raise rates in November?

• GBPUSD hits highest in a month ahead of tomorrow’s CPI inflation print
• Hike in November fully priced by markets…
• But will the MPC hawks have enough votes?

Recent commentary from senior Bank of England officials indicates the Monetary Policy Committee (MPC) will raise interest rates when it next meets in November, barely over two weeks from now. Market positioning has also shifted significantly in recent weeks from a single hike next year to one this year and at least two next, with the base rate expected to hit 1% by August.

BoE members have had numerous occasions to push back against market expectations and have led traders towards a November hike as being the most likely outcome. Over the weekend governor Andrew Bailey stressed that the Bank of England “will have to act” to counter inflation. That’s one for team sticky – which if you are a regular reader, you will know I’ve been saying all along. “That’s why we, at the Bank of England, have signalled, and this is another such signal, that we will have to act,” Bailey said. “But, of course, that action comes in our monetary policy meetings.” Ah, but which policy meeting did he mean? Did he mean November – the market certainly thinks so, and there has been no push back on that. Failure to raise rates next month risks Bailey becoming the Old Lady’s second unreliable boyfriend and the inevitable disapprobation for her taste in gentlemen.

Inflation problems

Inflation expectations in the UK increased to 4.1% in September from 3.1% in August of 2021. Actual inflation is also rising quickly. The latest Consumer Prices Index (CPI) rose by 3.2% in the 12 months to August 2021, up from 2% in July. The increase of 1.2 percentage points is the largest ever recorded increase in the CPI series, which began in January 1997. Soaring energy costs are a big factor, but the whole basket is seeing upwards pressure.

The reading of tomorrow’s CPI print is important. Another hot reading underlines the sense of urgency at the BoE. Cooler raises concerns that officials have got their communication muddled. It is once again expected to hit 3.2%.

Team sticky is winning for now but team transient have some cards up their sleeves. For instance, headline inflation would have been 0.3 percentage points lower in August 2021 without the Eat Out to Help Out discounts in August 2020. Demand destruction from higher prices may also start to feed into lower run rates for inflation.

Yield curve inversion

Markets are pricing in a fairly aggressive tightening cycle by the BoE. 2yr gilt yields have hit a two-and-a-half year high. This could be premature – the MPC may not be as hawkish as recent signals indicate, but if it’s correct then the market is also anticipating that the Bank would quickly need to reverse its actions. Forwards and implied interest rate expectations point to inversion – higher rates at the front end, lower further out. This only implies the market believes the Bank would be making a ‘policy mistake’ by hiking prematurely. Others would point out that taming inflation is its core mandate.

Certainly, the BoE like all central bank is dealing with something rather new: a supply shock. Central banks’ policy toolkits are based around levers to drive demand when it is low. They cannot fix supply crunches and imbalances in the economy very easily by stimulating demand. Nevertheless, the Bank is clearly mindful that allowing inflation to run rampant would a) destroy its credibility and b) allow longer-term inflation expectations to become de-anchored. If supply-side worries are longer lasting than first thought, and demand stays robust, it seems prudent for the MPC to use what tools it has to lean on inflation. What’s clear is that the intense debate around the recent comments and change in market expectations shows the Bank is not doing a particularly good job of communicating its position. We may be left in a position where the MPC hikes a couple of times and then has to dial it back, which risks its credibility – albeit whether more or less than it would by allowing inflation expectations off the leash is an open question.

The last meeting

• MPC voted 7-2 to maintain QE, unanimous on rates
• Ramsden joins Saunders in voting to scale back the QE programme to £840bn, ending it immediately
• CPI inflation is expected to rise further in the near term, to slightly above 4% in 2021 Q4 – and the BoE signalled greater risk it would be above target for most of 2022
• Overall, Bank staff had revised down their expectations for 2021 Q3 GDP growth from 2.9% at the time of the August Report to 2.1%, in part reflecting the emergence of some supply constraints on output
• Shift in forward guidance: MPC noted ‘some developments … [since the August Monetary Policy Report] … appear to have strengthened’ the case for tightening monetary policy.
• Rate hikes could come early, even before end of QE: “All members in this group agreed that any future initial tightening of monetary policy should be implemented by an increase in Bank Rate, even if that tightening became appropriate before the end of the existing UK government bond asset purchase programme.”

Doves vs Hawks

But will it go for the hike? The MPC is relatively evenly split in terms of hawks and doves, so it is not abundantly clear if the recent messaging from some members – albeit including the governor – matches with the votes.

Bailey has sounded hawkish, and we know Ramsden and Saunders are itching to act. Huw Pill, the new chief economist replacing Andy Haldane has also sounded hawkish, though less so than his predecessor.

Commenting after UK inflation expectations hit 4% for the first time since 2008, he said: “The rise in wholesale gas prices threatens to raise retail energy costs next year, sustaining CPI inflation rates above 4 per cent into 2022 second quarter.” We place him in the ‘leaning hawkish’ camp.

On the dovish side, Silvana Tenreyro is highly unlikely to vote for a hike next month, calling rate rises to counter inflation ‘self-defeating’.

Deputy Governor Broadbent said in July that he saw reasons for the inflation tide to ebb. The spike in energy prices since then could lead him to change his mind but for now, we place in the ‘leaning dovish’ camp,

Rate-setter Haskel said in May he’s not worried by inflation, and in July said there was no need to reduce stimulus in the foreseeable future. He goes in the Dovish camp with Catherine Mann, who said last week that she can hold off from raising rates since markets are doing some of the tightening already. “There’s a lot of endogenous tightening of financial conditions already in train in the UK. That means that I can wait on active tightening through a Bank Rate rise,” she said.

That leaves Jon Cunliffe somewhat the swing voter. In July he stressed that inflation was a bump in the road to recovery. We look to see whether the recent spike in inflation and inflation expectations has nudged the likes of Cunliffe, Pill and even Broadbent to move to the Hawkish camp. It seems unlikely that governor Bailey would have pointed the market towards quicker hikes if he did already have a feeling for the MPC’s views on the matter.

Dovish  Leaning dovish  Centre  Leaning hawkish  Hawkish 
Tenreyro

Mann

Haskel

Broadbent Cunliffe Pill Saunders

Ramsden

Bailey

Charts

GBPUSD: The hawkishness from policymakers and market repricing for hikes has supported £, though we do note some noticeable dollar weakness in Tuesday’s session that is flattering the view that it’s all BoE driven. Cable breaks new highs ahead of CPI, above 1.3820 to test the 50% retracement off the May peak. Bullish MACD crossover still in play, but starting to look a tad extended.

GBPUSD Chart 19.10.2021

EURGBP Gains capped with a stronger EUR today, but has made a fresh 18-month high. BoE racing to hike against a much more dovish ECB ought to be positive, but yield curve inversion highlights the dangers of viewing FX trades purely from a CB tightening/loosening point of view.

EURUSD 19.10.2021

ECB preview: no big changes ahead of Jun 10th meeting

  • No material changes expected 
  • More hawkish (EUR positive) more likely than more dovish 
  • Brighter economic outlook since March 

The European Central Bank (ECB) convenes on Thursday (Jun 10th) amid a much rosier economic outlook than at the start of the year. But with the central bank having communicated its plans to front-load asset purchases, there is not expected to be any material change in policy or communication. It will be hard to avoid taper talk so how the ECB responds to questions around tapering will be of central importance to the market’s expectations and the euro. 

At the March meeting the ECB said it would pick up the pace of asset purchases, front-loading the PEPP scheme, but that it could still use less than the full envelope of €1.85tn if favourable financial conditions can be maintained without spending it all. The outcome of the March meeting was very much that the PEPP programme is more likely to end by March 2022 than be extended, albeit policy will remain very accommodative well beyond that point.  

To taper? 

Yields have been pressing higher but have retreated from the May peaks. The increased pace of asset purchases that was agreed in March came as a response to rising yields at the time. But the economic outlook – chiefly driven by a strong vaccine rollout that was slow to start but is now firing on all cylinders – has improved greatly since then. The ECB has been taking the line that inflation is temporary and rising bond yields reflect better fundamentals, so I don’t think it will be unduly concerned by a higher rate environment now due to the better economic picture. This will make talk of a taper very difficult to ignore. The language around the speed of asset purchases may change somewhat, and this could drive EZ yields + EUR higher. It will be very interesting to see what the ECB says about the state of financing conditions and it is sure to continue to tie PEPP purchases to maintaining these as ‘favourable’.  

The big risk for EUR crosses around this meeting is: does the ECB silence taper talk with enough vigour to keep yields in check, or does it allow the market to think the more hawkish voices are winning the argument about when the central bank eventually exits emergency mode. 

New projections 

Inflation has picked up since the last meeting, which could see the forecast for 2021 and 2022 revised upwards from the March level. EZ inflation rose to 2% in May from 1.6% in April, the first time it’s been on target in over two years. With growth in Q1 a little light, the rebound in the summer should mean GDP projections remain broadly unchanged. 

What has the ECB been saying lately? 

ECB speakers have been offering a few titbits since the last meeting. Of particular importance to the speed at which the ECB will exit emergency mode, Christine Lagarde stressed that inflationary pressures will be temporary – sticking to the global central banker script. At the April meeting she said tapering talk was premature. 

Kazaks and Lane made it clear policymakers will look at the asset purchase programme again in June, which could involve scaling back the programme if the economic situation is better.  There were dovish comments from the Panetta in late May, noting that it was too early to taper bond purchases. Banque de France Governor, Villeroy de Galhau, stressed that the ECB is going to be at least as slow to tighten as the Federal Reserve. 

But we’ve also had warnings about financial stability risks stemming from rising levels of sovereign debt. Vice president de Guindos warned of a “legacy of higher debt and weaker balance sheets which … could prompt sharp market corrections and financial stress”. 

Technical outlook 

Right now, the price action has flipped above the 5-day moving average (RHS), so we look for a confirmation of this move (close above today and a green candle again tomorrow) for a bullish signal. On the LHS, the longer-term view of the daily MACD divergence is raising a warning flag. 

US pre-mkt: Another wobble as US inflation surges to 13-year high

A Volcker-era inflation print: US inflation surged in April, with the year-over-year CPI reading coming in at 4.2%, the highest since Sep 2008 and easily beating the 3.6% expected. Prices rose 0.8% month-on-month, ahead of the 0.2% forecast. A 10% increase in used cars and trucks was the most eye-catching reading with sub-indices (see table below).

The gauge of core inflation made for even more interesting reading, at +0.9% mom and +3% yoy (see chart below). The mom reading was the highest since 1982 when Volcker was in full inflation-busting mode. We can look to lots of things like base effects, supply chain trouble, reopening, pent-up demand, stimulus effects etc as being behind this jump in pricing. Nevertheless, it’s happening; and this perfect storm for inflationary pressures is not about to go away immediately, even if it does, in the end, prove transitory. Yes, it’s predicted – albeit a little hotter than expected – but it’s still bound to stoke worries in the markets about inflation and rising nominal yields. Keep your eyes on the wage growth and job openings for the real inflationary pressure.

As we have noted previously, we can expect a series of hot prints this summer; the Fed has made it clear it will look past these as it thinks inflation will be transitory. We shall only really know if that is the case in a few months’ time. Until then expect gyrations as data shows strong inflation and growth, even if it’s largely predicted.

US CPI chart showing inflation spike.Table showing y-o-y CPI percentage increases.

Market reaction: Nasdaq futs predictably fell, benchmark 10-year yields rose to 1.65%. 10-year TIPS breakeven inflation rate rose to 2.591%, the highest since 2013. S&P 500 futs were weaker too but pared some losses ahead of the open. NDX set to open around 13,175, a wee bit above yesterday’s lows under 13,100. Vixx spiked above 23 before settling into the mid-22s.

The FTSE 100 tumbled to day lows at 6,950 on a broad algo-like reaction to the data before rallying to 7,000 again investors woke up and remembered that higher inflation is net good for the UK market since it’s weighted to cyclicals not tech. Strong inflation readings ought to support the UK blue chip index. The dollar caught some bid initially, with DXY spiking to 90.67 on higher yields before giving them all back in short order to sit around 90.30 at pixel time.

Cluster of indices charts showing reactions to US inflation spike.

EURUSD moved in a wide range on the release and is now trending to the upside.

EUR/USD chart from 12th May 2021.

UK preliminary GDP q/q preview (Wed, 07:00 BST)

The Bank of England anticipates UK economic output contracted by 1.5% in the first quarter of the year, which should be pretty much our reference point for the print on Wednesday, with the consensus at –1.6%. The –2.2% in January was stronger than expected and was followed by a 0.4% expansion in February. Whilst March data does not capture the reopening of non-essential shops, there is evidence that spending and activity were already picking up before the Apr 12th easing of lockdown restrictions. Moreover, the UK economy has proved to be a lot more resilient to lockdown 3 than lockdown 1. Put that down to the adjustment of people and business to the displacement; for instance the embrace of remote working, as well the lockdown rules themselves being less restrictive to economic activity than the first lockdown a year before. Better and more comprehensive testing has also played an important part in keeping in most economic activity going.

The March IHS Markit / CIPS services PMI showed a strong rebound in March, with the index rising to 56.3 from 49.5 in Feb. The robust PMI coupled with other evidence of increased card spending and mobility suggest a solid bounce back in the final month of the quarter, with a month-on-month expansion of around 1.3% expected. Whilst not a direct read on the Q1 numbers, Barclays today says that April card spending has exceeded pre-pandemic levels.

But this all remains rear-view fare: the market is more interested in the +7% growth expected in 2021 which is going to imply some pretty impressive expansion in the third and fourth quarters in particular. Strongest expansion since WW2 is more eye-catching than a mild contraction in Q1 that has been well and truly priced. Going forward, we are not really going to know what the true size of the economy really is for some time because there has been a huge displacement in economic activity as well as the velocity of people. Adjusting to this new normal will take time and measures of output will always lag what is really happening. Moreover, as Friday’s nonfarm payrolls report in the US evinces, hard data is liable to being way off forecasts because it’s so hard to get a handle on what we are comparing it with; furlough and other emergency schemes masked the true depth of the economic contraction. Just as the pandemic led to an unprecedented contraction, there is not really a playbook for this recovery, so we should be careful not to over-read individual prints.

By way of context, the NIESR this morning estimates that the UK economy will recover 2019 levels by the end of 2022. The recovery is strong but it’s coming from a low base. To add further context, as of Feb the British economy remains 7.8% smaller than it was a year before. Moreover, it is still 3.1% below where it was at the peak of the post-lockdown recovery in October 2020 – evidence that this long third lockdown over the first quarter has set things back some way. NIESR also estimates that UK unemployment will peak at 6.5% rather than 7.5%, reflecting the extent to which government support schemes have masked what is really going on.

Chart showing UK GDP performance.

BoE quick take: sterling hits one-week high as MPC exits emergency mode

This was not as hawkish as some might have wanted but it’s a clear signal the Bank of England is exiting emergency mode.

The Bank of England left interest rates on hold at 0.1% and maintained the size of its asset purchase programme at a total of £895bn. By way of a hawkish parting shot Andy Haldane dissented and voted to lower the gilt purchase envelope from £875bn to £825bn. His views are no longer particularly relevant to future monetary policy decisions since he is leaving after the June meeting, but it certainly underlines the fact that the Bank is exiting the emergency phase. Unless there is another deadly wave and new lockdowns the next move on rates will be up.

Whipsaw: Sterling spiked lower on the release, with GBPUSD dropping under 1.3870 from a high above 1.3920 earlier this morning before reversing course and hitting fresh daily highs north of 1.3940, since Apr 30th. Looks as though the slowing of bond purchases to a weekly rate of £3.4bn from £4.4bn amounts to a taper, but it appears to be not much more than the kind of technical taper that had already been flagged in February. Gilt yields are steady with the 10-year at 0.82% and 2-year around 0.050%. The FTSE barely budged and is steady above the all-important 7040 area, though back down from the highs of the day closer to 7070.

The Bank stressed the decision to ‘somewhat’ slow purchases is an ‘operational decision’ and ‘should not be interpreted as a change in the stance of monetary policy’. This is up for debate – it at least signals the Bank’s confidence in the economic recovery, otherwise it would keep on at the higher rate and stand ready to increase the size of the envelope. But we also must acknowledge that it’s really about creating an gentler run-off for QE than might otherwise be required later in the year to avoid exceeding the envelope. On the whole it looks as though the FX market doesn’t see this as particularly hawkish with cable failing to make good on the breach of 1.3940 and settling back to around 1.3920.

The growth outlook is much improved this year with the Bank forecasting growth down a little in Q1 and then a sharp recovery in the second quarter, though activity will remain about 5% below the same period in 2019. The economy is expected to recover to pre-pandemic levels over the course of 2021, however GDP growth is seen cooling over the rest of the forecast period. The MPC also stressed that the outlook for the economy remains ‘uncertain’. The bank reiterated that spare capacity in the economy is expected to be eliminated in 2021 and there is a temporary period of excess demand, before demand and supply return broadly to balance.

Pull-forward in demand: The Bank revised 2021 growth up to 7.25% from 5% in the February Monetary Policy Report, but revised growth for 2022 down to +5.75% in 2022 from a previous forecast of 7.25%. The impact of the vaccine rollout is clear to see from this. 2023 forecast remains at +1.25%. Inflation is forecast to return to 2% in the medium term, and hitting 2.3% in a year’s time. Overall it looks like the Bank sees inflation staying well under control over the forecast period, which does not indicate it will be in a hurry to raise interest rates.

Whipsaw move sees GBPUSD hit its highest since end of April before easing back to be almost flat on the session.

Chart showing GBP response to BoE rate decision.

FX primer: A big week ahead for the pound?

• Scottish election: breakup risks?
• Bank of England meeting
• Sterling struggling to recapture 1.40

Scotland’s elections on May 6th combined with a Bank of England (BoE) meeting create a good deal of event risk for sterling crosses, gilts and UK equities next week.

First to the elections, where results will be closely watched by the FX markets for a signal on a possible second independence referendum. Whilst Boris Johnson has been clear on not allowing another referendum in this Parliament, strong SNP support would be considered by Nationalists are a firm vote of confidence and would create impetus behind calls for Indyref2. First minister Nicola Sturgeon says a majority of pro-independence MSPs, which would include SNP, Greens and perhaps any new Alba MSPs, would deliver a mandate for another referendum. I do not want to get into the weeds of polling figures and the permutations of the Scottish regional list ballot system; however, it is worth a quick look at the latest figures.

A Panelbase survey suggests the SNP will fall short of an absolute majority, but pro-independence MSPs would have a majority in Holyrood. The survey points to 61 SNP MSPs (down two from 2016), 24 Conservatives (down seven), 20 Labour (down four), Greens 11 (up five), eight for Alex Salmond’s Alba and five for the Liberal Democrats. A poll by Survation predicted that the SNP is on course to win a five-seat majority. Based on this assumption, and an expected strong showing for nationalists (be they Green, SNP or Alba), it’s likely Nicola Sturgeon will remain as first minister and there will be renewed calls for independence.

Since the Brexit vote and subsequent agreement (now finally ratified), the case for independence has taken on a new tone. Scotland, argue the nationalists, voted to remain in the EU. The 2014 once-in-a-generation vote is irrelevant since things have changed within the UK, they say. Scots said no to independence believing they’d stay in the EU. Such constitutional grumblings are of course non-sensical; Scots voted to remain part of the UK, the UK then voted to leave the EU: that’s life. It’s not a buffet. I daresay my corner of the Chilterns voted to remain, but it is an irrelevance.

Putting all of this to one side, as far as markets are concerned the election in Scotland is ‘one to watch’. UK break-up risks could be a factor in holding sterling back right now. A victory for nationalists could create further unease and is certainly one to watch for GBP crosses in the coming days. However, given the British government’s position, I see no actual risk of a breakup of the UK in this Parliament. Longer-term, Scottish nationalism will continue to act as a headwind to sterling.

Then we have the Bank of England meeting, also on May 6th. Don’t expect any change to monetary policy, however the much brighter economic outlook certainly points to the Bank being able to wind down emergency mode earlier. With QE running at a pace of slightly more than £4bn in gilt purchases weekly, the focus will be on at what point the MPC chooses to signal it will slow this down later this year. The contraction in GDP in the first quarter was not as bad as feared as the economy showed far greater resilience to lockdown 3 than lockdown 1, whilst the success of vaccinations is becoming abundantly clear and means lifting of all restrictions by June 21st is looking more and more likely. The vast majority of economic activity will ‘normalised’ by May 17th. Therefore, there is a risk that the Bank announces plans to taper asset purchases at this meeting, sooner than the market is maybe anticipating. This would likely be positive for sterling since FX markets continue to under-price MPC hawkishness.

The Bank forecast a 4% decline in Q1 (quarter-on-quarter), however the data so far indicates that the contraction was milder than the February projection. Growth estimates for the full year may well be revised higher from the current 5% level. This may provide ammunition for an earlier taper, however the MPC may prefer to wait longer (say June, when the extent of the reopening will be better appreciated) in order to engineer a steeper taper in the second half of the year.

Markets are currently pricing a small hike this year, and 50 basis points over the three years of the BoE’s forecast horizon. While all the chatter was about negative rates, it has become clear that the next move by the MPC will be to raise rates, unless of course we get another exogenous shock.

Ahead of next week’s meeting we have seen some mild tightening as 10yr gilt yields crept higher and we could see tightening further before or around the meeting in anticipation that the BoE does not seek to push back against those market expectations. Teeing up a taper could see the yield on the 10-year gilt rise back to the March peak at 0.87%, which would be sterling positive. Ultimately the question about tightening is really one of timing, but the BoE cannot be blind to the economic data and this meeting could be the time to fire the starting pistol.

GBPUSD has resolutely refused to break out of the week’s range and mount any attempt to scale 1.40. Price action has centred on the 38.2% retracement area at 1.3890. With little appetite to take on 1.40 for now we could see a retest of 1.3860 in the near-term, with a drift to 1.380 and the 23.6% retracement a possible area to look at on a dip. Scottish risks may be put to one side by traders focused on the here-and-now of gilt yields and potential tightening into the BoE, helping to create the conditions for another attempt to clear the big round number. Bullish crossover on the hourly MACD is useful. On the daily chart the bullish crossover from two weeks ago is still in play but momentum keeps fading at the 1.39240 area this week. (daily on the left, hourly on the right).

Chart showing GBP movement against USD.

Cable hits 6-week low

Looks to be a pretty soggy morning for risk as sterling slipped to its weakest since the start of February, whilst the dollar is bid, shares slipped, oil fell and bond yields retreated ahead of the Congressional testimony of Fed chair Jay Powell and Treasury Secretary Janet Yellen. We kind of know where the Fed is at in terms of yields, inflation and accommodation. We will want to hear a lot more about what Yellen says on additional stimulus, with Biden’s mooted $3tn plan in the offing. FTSE 100 trades around 6,700 by 10am, down -0.3%, with the DAX -0.5% for the session. US futures still lower, Vix nudging up. US 10s are lower at 1.644% and copper is weaker by more than 1% and WTI futures dropped over 3% back under $60.

GBPUSD sank to a 6-week low as the 50-day simple moving average went at 1.382 and then the round number broke to see the cross test 1.3770. Looking at the 78.6% retracement around 1.3750 for support. I’d still be confident the pound will be retest 1.40 and break above that when it does.

GBPUSD has sunk to a 6-week low.

The dollar is finding bid across the board this morning, with EURUSD dropping 30pips or so in the last 3 hours to under 1.19, with a potential retest of yesterday’s lows around the 1.1875 area. Key 200-day SMA coming in around 1.1850.

EURUSD dropping 30pips or so in the last 3 hours to under 1.19.

WTI futures looking to the downside today as risk is offered and markets fret over the rise in cases in Europe and a shorter holiday summer season. As flagged in today’s morning call briefing the potential bearish wedge has already broken down, looking to the 50day SMA around $58.80.

WTI futures looking to the downside today.

Old Lady lights a fire under Betty: Cable soars as next move on rates should be up

The Old Lady has lit something of a fire under sterling: The Bank of England left rates unchanged at the record low 0.1% and the stock of asset purchases steady at £895bn. There was no surprise in either as the Bank has plenty of ammo left in the tin in terms of QE and any thoughts about negative rates are premature to say the least. Indeed I would say that this latest update indicates the next move on rates will be to hike when the recovery takes hold and inflation picks up as spare capacity is eliminated – perhaps not soon but the direction of travel is surely away from negative rates and towards hiking, perhaps in 2022.  Sterling and gilt yields responded by shooting higher, with 2-year yields jumping from -0.1% to -0.05%.

 

We got a confident outlook too – the Old Lady thinks the UK economy will recover quickly to pre-pandemic levels of output over the course of 2021. It expects spare capacity in the economy to be eliminated as the recover picks up steam this year, which begs the question: is the next move up? I think so, although clearly the Bank is at pains to leave negative rates in the toolkit.  

 

Key passage: GDP is projected to recover rapidly towards pre-Covid levels over 2021, as the vaccination programme is assumed to lead to an easing of Covid-related restrictions and people’s health concerns. Projected activity is also supported by the substantial fiscal and monetary policy actions already announced. Further out, the pace of GDP growth slows as the boost from these factors fades. Spare capacity in the economy is eliminated as activity picks up during 2021.”

 

It also stressed that the GDP performance in Q4 was “materially stronger” than it thought in Nov. The thing is lockdowns #2 and #3 are not as economically damaging as mark 1. However 2021 gets off to a slow start – GDP is expected to fall by around 4% in 2021 Q1, in contrast to expectations of a rise in the November Report. This is no surprise since lockdowns are lasting much longer than we thought they would back then. But the important thing is the rapid elimination of spare capacity this year. 

 

Not only did the BoE say that it does not intend to signal that negative rates are coming, but it also – from my reading of the Monetary Policy Report – suggest that the next move on rates will be to hike. If spare capacity is eliminated this year and inflation progresses to target there will be a move to raise rates. The MPC itself stated: “The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.”

 

But on the face of things, it seems we will see inflation pick up (PMIs are telling us this), whilst oil prices are rising, Brexit will raise some costs inevitably, and pro-cyclical stimulus and vaccines will create a strong tailwind to growth this year. The rapid rollout of vaccines cannot be underestimated as far as inflation goes and the MPC reckons CPI is expected to rise quite sharply towards the 2% target in the spring, and hit 2.5% in 2022. This may be far too conservative. Coupled with a strong economic recovery may present the MPC with a dilemma about when it needs to tighten policy. It could be sooner than expected – it all depends on the vaccines of course so we should treat this with caution.

 

Sterling liked the MPC taking a bit of step back from the negative rate precipice. GBPUSD advanced to the 50-hour SMA at 1.36470 and reversed the near-term momentum to the downside.

Cable hits YTD high, OPEC decision coming

Sterling rose to its highest against the US dollar in 2020 with the greenback coming under more pressure this afternoon in a repeat of yesterday’s moves as the weaker dollar narrative shows no signs of running out of gas. GBPUSD advanced beyond 1.3490, its best since the Boris Bounce of Dec 2019 after the Conservatives won a strong majority and a run at 1.35 seems ‘on’ for bulls now.

That would see cable back to levels not seen since the soft Brexit narrative-driven 1.43 area of spring 2018. The moves are probably two-fold – one is clearly about dollar weakness with majors posting solid gains vs the buck. The other cause may be markets front-running a Brexit deal with indicators the UK and EU negotiators are heading towards the ‘big push’. Don’t worry lads, we’ll be eating sauerkraut in Berlin by Christmas…we know what overplaying Brexit headlines has been like but it feels like this time is different simply because we are running out of road.

EURUSD has risen to its strongest in over two and a half years, rising above 1.2170. As noted when we saw 1.20 breached, there is not a huge amount of resistance blocking a return to 1.25. USDJPY dipped under 103.70, its lowest since the Nov 6th low which preceded the massive Nov 9th rally. Dollar index making new lows as a result with pressure on all fronts taking it to some near-term support at 909.50. Little support through to 88.

Cable has hit a YTD high today.

Meanwhile, a word on OPEC – as of send time the meeting had begun with sources pointing to increase production slowly at a rate of 500k bpd from next year, either from Jan or Feb. WTI seems happy enough with $45 on the headlines but we await the final decision.

 

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