BOE Preview: Pound, Gilt Yields Seen Capped on Brexit Caution

  • JPM AM remains positive on gilts as BOE to stay on hold
  • Risk-reward seen favoring an increase in front-end rates

RBS Chairman Davies Expects BOE to Hold Rates Steady

The Bank of England is likely to revise higher its inflation outlook for the year, though Governor Mark Carney is bound to talk down expectations for a rate increase anytime soon, analysts say ahead of this week’s monetary-policy review.

What is likely to capture the market’s imagination is whether more than one person among those voting calls for a rate increase, they say. The BOE is scheduled to announce its policy decision at 12 p.m. in London on Thursday, followed by a press conference by Governor Mark Carney 30 minutes later. The central bank will leave its benchmark rate unchanged at 0.25 percent, according to all 55 economists in a Bloomberg survey.

The BOE will also release its Quarterly Inflation Report, where it will raise its 2017 inflation forecasts and lower its economists growth projections, according to analysts.  

  • Markets have wiped out the prospects of a rate increase at least until November 2018,  MPC-dated Sonia show.
    • This is in contrast to March when there was a near-50 percent chance of a 25 basis point rate increase by mid-2018.
  • Given the current level of market pricing, strategists suggest risk-reward favors positioning for an increase in front-end rates, and a steeper term structure. 
  • JPMorgan recommends owning options targeting a rise in 2019 money-market rates and hold position targeting steepening between one- and two-year Sonia forward rates. Deutsche Bank recommends short February 2018 MPC-dated Sonia.
  • With the U.K. snap elections on June 8, the BOE will likely refrain from any market surprises, analysts say.

Below is a compilation of investors’ and analysts’ expectations for the meeting, and the outlook for gilts and the pound:

JPMorgan Asset Management

  • “We expect the BOE to look past the rise in inflation” and be more concerned with how slowing growth will affect prices in the longer term, says David Tan, head of rates at JPMorgan Asset Management, which oversees $1.8 trillion.
  • Looking for slight outperformance in gilts “because we do not expect BOE to raise rates. We are slightly positive on gilts, but there’s not a lot on that as bond yields have been range-bound globally.”
  • “The Article 50 process has barely begun and it will have an impact on confidence, investors intention. So the BOE might talk tough but might act quite dovishly and stay put.”

Toronto-Dominion Bank

  • It will be hard for the pound to go much higher than $1.30, according to TD Bank analysts led by head of global strategy, Richard Kelly.
  • “2017 growth will be revised down and inflation up, but 2018-19 will remain broadly unchanged as a lower yield curve/ oil prices and a stronger currency help offset recent data surprises,” they wrote in a client note. 
  • “Markets may respond to this hawkishly initially, but Governor Carney will likely steer things back to neutral during the presser.”
  • “A lone Forbes dissent could also mitigate any hawkish undertones which leaves GBP vulnerable to a pullback given the shift in market positioning and recent repricing of risk,” TD analysts said, adding that they would like to “fade GBP-USD on rallies into $1.30.”
  • “With blackout rules in place during the election campaign, the BOE is unlikely to rock the policy boat too much.”

Citigroup Inc.

  • “The gilt market feels a little lost for direction,” write analysts at Citi, including Jamie Searle. The Inflation Report “is the kind of event which might kick it into life.”
  • The risk-reward certainly looks “asymmetric as it approaches,” they say, with it being “hard to imagine the MPC being more dovish than market pricing. And the MPC may want to add some two-way risk into the front end and remind the market that there are scenarios in which hikes become probable.”
  • This week “may not be the right time to do this. The proximity of the general election is one reason not to rock the boat.”
    • Also, recent strength of sterling and softer data on the consumer side “are further reasons why this may not be the right time to sound overly hawkish. That leaves gilts stuck in the range, for now.”

Deutsche Bank AG

  • U.K. data are yet to “show signs of a deterioration beyond the slowdown already projected by the BOE” and inflation is set to rise, analysts including Francis Yared write in a client note.
    • “With the BOE therefore unlikely to shift its underlying judgment of the outlook at the May meeting, front-end pricing looks rich and we add a paid 1Y1Y Sonia vs. USD.” 
    • “We maintain the UKT 5s10s steepener given the slope remains excessively flat to models. And the current richness of the U.K. points to the market pricing an excessive probability of further QE from the BOE.”

Morgan Stanley  

  • Suggests 2s10s gilt curve flatteners and likes them more than the outright long because “there is significantly less priced in for MPC rate hikes than there was in late January, i.e., around 10bp over the next year and 20bp by March 19,” analysts including Anton Heese write in a note.
  • Even though the bank’s economists don’t expect the BOE to raise rates any time soon “there is potential for more speculation on the issue, especially if more than one MPC member decides to vote in favor of a rate hike” at this week’s meeting.
  • A short position at the front end of the curve “provides us with some protection against an MPC-induced sell-off in U.K. yields,” they say.
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