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The Bank of England raises rates: Bearish for the pound

 

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The latest data indicate that the market is only slightly short GBP and we think that this view is too optimistic.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Bank of England (BoE) raised rates for the first time in more than a decade and the pound dropped. What is your reading of this?

Bastien DRUT: The reaction of the pound to the MPC (Monetary Policy Committee) has been very negative. The pound experienced its biggest daily loss versus the Euro since the Brexit referendum and the UK 10 year declined by around 10 bps on the announcement. Globally, we have a bearish view on the pound. The Brexit negotiations are falling behind and the risks of failure are rising gradually. The BoE itself states that “There remain considerable risks to the outlook, which include the response of households, businesses and financial markets to developments related to the process of EU withdrawal.” The uncertainties linked to the Brexit are already weighing on the macro indicators, which will prevent the BoE from pursuing a standard rate tightening cycle and this environment is negative for the currency. We also should underline that the UK is one of the countries with the largest current account deficit in the world as there has been little improvement of the current account dynamics despite the pound depreciation that followed the referendum. The latest data indicates that the market is only slightly short GBP and we think that this view is too optimistic.

What is your assessment of UK economy?

Tristan PERRIER: The initial resistance of the UK economy to the result of the June 2016 Brexit referendum was much stronger than anticipated. Helped by a large GBP depreciation, GDP growth remained strong in H2 2016 whereas many observers had expected a recession. However, since the beginning of this year, cracks have appeared. Over the 3 first quarters of 2017, despite a small upward surprise in Q3, the underperformance relative to the Eurozone has been significant (with a real GDP advance of +0.9% vs +1.8%).
 High inflation, directly related to the GBP depreciation, is eroding consumers’ appetite while, despite a very low unemployment rate, there is still no acceleration in wages. Looking forward, even though inflation should gradually decline, we are expecting Brexit-related uncertainty to weigh heavily on investment decisions, both from corporations and households (the latter regarding real estate, which would also be vulnerable to further increases in interest rates). While the risk of a “very hard” Brexit (with no agreement) is not our base scenario, its perceived probability may increase, at least temporarily, in the coming months. More generally, as with a number of other developed economies well advanced in the current expansion cycle, there are also major interrogations about whether the current very low unemployment rate really means that the economy is running near its full capacity, a key question for monetary policy.

 

The Fed kept rates unchanged in November meeting. What is the FOMC assessment of the economy?

Annalisa USARDI: As anticipated, the Fed made no changes to monetary policy in its October FOMC meeting.
The assessment of the economy is in line with our views: labor market is strong, incrementally absorbing the slack derived from the Crisis. Since September the labor market has continued to strengthen notwithstanding the drop in payroll caused by the hurricanes and the unemployment rate has continued to decline, perhaps below NAIRU[1]. The economic activity has been rising at a solid rate despite hurricane-related disruptions. Federal Reserve District Surveys point to positive current assessment and expectations for the next 6 months. Household spending has been expanding at a moderate rate, supporting internal demand as well as growth in business fixed investment which picked up in recent quarters (although some of it may be linked specifically to the mining oil and drilling). September headline inflation was temporarily boosted by Gasoline prices due to the hurricanes factor; however core inflation remained soft. On a 12-month basis, both inflation measured are running below 2%.

From a Multi-Asset perspective do you see any opportunities on UK assets?

Francesco SANDRINI:At this stage, we believe investors should keep a cautious view on UK assets. We believe that the recent move of the BoE comes at the wrong time and further increases the risk of stagflation in the UK, with CPI at 3% - the highest level in five years - and a weak GDP growth. As we expect the pound to continue to be under pressure, we believe investors should remain short GBP vs Euro and USD. In the fixed income space, we believe that real rates should be lower than the current level, so investors should keep a short view on real rates. On the equity market, we have a neutral view: while a weaker pound is a tailwind for exporters, the outlook for internal demand is weaker. In Equity, we prefer other markets: Eurozone (favoured by the European renaissance story), Japan and selectively on EM.

PERRIER Tristan , CFA, Strategy and Economic Research at Amundi
DRUT Bastien , Strategy and Economic Research at Amundi
SANDRINI Francesco , Head of Multi-Asset Balanced, Income & Real Return
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The Bank of England raises rates: Bearish for the pound
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