Rates Traders See BOE Resisting Urge to Follow Fed's Trajectory

  • BOE outlook seen unchanged by first Fed increase since 2006
  • Inflation collapse is behind BOE's struggle to boost rates

Traders have stopped assuming that once the Federal Reserve raises U.S. interest rates, the Bank of England will follow soon afterward with a similar move.

With the Fed widely expected to increase interest rates on Wednesday, futures show BOE policy makers waiting until 2017. While most analysts judge that to be overly pessimistic, they don’t see a material change following a Fed move. The reason: Britain’s inflation has remained tame, limiting the scope for its central bank to raise the benchmark price of money.

Going at different speeds on monetary policy is not the norm. In the past 20 years, the BOE has tended to follow its U.S. counterpart with a lag of about three months, as the two economies became more intertwined, according to economists at Deutsche Bank AG. In 2014, markets were forecasting the BOE would raise before the Fed.

“The BOE seems to be gradually decoupling from the Fed,” said Valentin Marinov, head of Group-of-10 foreign-exchange strategy at Credit Agricole SA’s corporate and investment bank unit in London. “Right after Fed liftoff, investors may still see the Fed on its own, tightening policy, with the BOE still undecided whether to follow in the Fed’s footsteps or not.”

‘Constructive Fed’

There is a divergence between “the constructive Fed, still very much on course to hike rates before long, and the cautious BOE sounding increasingly dovish,” Marinov said.

Traders on Tuesday were pricing in a 78 percent chance of U.S. policy makers raising the target rate off a record low by Wednesday, data compiled by Bloomberg show. In early August, the last time the chances were that high, forward contracts based on the sterling overnight index average, or Sonia, were signaling BOE liftoff by May 2016, compared with February 2017 on Tuesday.

“I don’t think that the rate hike from the Fed is likely to have much impact on expectations for the first hike from the BOE,” said Lee Hardman, a London-based currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. “If you look at the BOE minutes they quite clearly stated BOE policies are not dependent on Fed or ECB policies,” he added, referring to the European Central Bank.

2017 Liftoff?

While traders stick steadfastly to pricing in a 2017 BOE liftoff, analysts say the sluggishness is not all about plummeting oil. It also about paychecks. Wage growth must speed up before interest rates can be raised, BOE Deputy Governor for Markets and Banking Minouche Shafik said on Monday. She didn’t estimate how much time remains, though she said it has been misjudged by markets.

Her colleagues on the BOE’s Monetary Policy Committee have commented in recent weeks on what’s needed to move the base rate off its record-low level. But the signals have been mixed -- muddying the outlook for investors.

Just a little more than a month ago, BOE Governor Mark Carney said there was a good case for rates to rise in 2016, “given the progress this economy is making.” Since then the central bank has sounded more cautious, with the minutes of its latest meeting released on Dec. 10, saying low oil prices and subdued wage growth will keep a lid on inflation.

BOE officials said there “was no mechanical link between U.K. policy and those of other central banks, and the U.K. policy stance would be determined ultimately by the inflation outlook here.”

“A current inflation rate of at least 1 percent is probably a prerequisite for the MPC to start raising interest rates,” said Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics Ltd. in London, in a note to clients.

Tombs said the central bank has never tightened policy when the inflation rate was “more than 1 percent below” its 2 percent target. Inflation was 0.1 percent in November.

Even so, Tomes predicts the “first rate hike in May, alongside the MPC’s Inflation Report, about six months earlier than markets expect.”

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