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GBPUSD made a 5-week high around 1.3832 early Tuesday and off the low 1.3412, jumped almost +2.60% in October (till date) on an imminent rate hike jawboning by BOE Governor Bailey to control inflation. Earlier, USDJPY made a 9-month low around 1.3412 on China’s Evergrenade debt default fiasco and European energy crisis (skyrocketing LNG prices). The U.K. headline CPI jumped +3.2% in August, while the core CPI also soared to +3.1% and inflation expectations (one year ahead) surged to +4.1% in September, all far higher than the BOE target +2.0%. The headline unemployment rate was 4.5% in Aug’21 against pre-COVID (Jan’20) levels of 3.9%.
Against this economic backdrop, on Sunday, the BOE Governor Bailey said in an online panel discussion organized by the Group of 30 consultative group that BOE has to act to contain inflation in the forthcoming meetings:
"I continue to believe that higher inflation will be temporary because it is in the nature of the underlying causes. But the energy story particularly means that it will last longer and it will of course get into the annual numbers for longer as a consequence of that. And that of course raises for central banks the fear and concern of embedded inflation expectations. As I've said before, monetary policy cannot solve supply-side problems, but it will have to act and must do so if we see a risk particularly to medium-term inflation and to medium-term inflation expectations, and that is why we at the BOE have signaled - and this is another such signal - that we will have to act. But of course, that action comes in our monetary policy meetings.
I think the demand for workers in Britain had been stronger than expected and the number of younger and older workers leaving the labor market had grown. I do have concerns about labor supply growth—but I do not believe there was a general pattern of labor market pressure as wages climbed strongly in some sectors but less so in others--- here were lessons for governments seeking to prevent future supply chain shocks in the way financial regulators had responded to the shock of the global financial crisis of 2007-09, including regular stress tests. I'm not saying we have the magic answer to supply chains across the board, but I think there are lessons that we have learned in terms of resilience that can usefully be adapted and used and translated into some other markets, particularly for instance when I look at energy supply”.
BOE policy at a glance:
BOE is traditionally heavily dependent on jawboning and a conservative central bank; compared to Fed, ECB, and BOJ, it has negligible QE and the main policy tool is bank rate (reverse repo), which now stands at +0.10% against Fed’s +0.15%. The BOE repo rate is +0.35% against Fed’s +0.25%, while the interbank rate is +0.10% against Fed’s +0.125%.
The BOE Governor Bailey was talking about the negative reverse repo rate till a few months ago when GBPUSD was hovering around 1.38. The market is now expecting a hike of +0.15% in both repo and reverse repo rate by BOE in Nov’21 or subsequent Feb’22 policy meeting (with a presser). The BOE also signaled QE tapering to tighten in its August and September monetary policy report to control elevated inflation (be it transitory or not). But considering the history of BOE jawboning and actual action, it’s very hard to believe that BOE will go for a pre-emptive rate hike in Nov’21 or Feb’22 even before Fed’s late 2022 expected liftoff and that too without any official QE tapering plan.
Overall, at a glance, BOE is reducing its monthly pace of QE bond-buying, while extending the same, keeping the total envelope slightly higher. BOE is currently buying QE bond around ₤4.40B/week for its latest pandemic QE envelope ₤150B (Jan’21-Nov/Dec’21) announced in Nov’20. Like ECB, the BOE will also be flexible in buying QE bonds as per evolving economic situation but is not desperate to bring down UK bond yield below or around zero. Cumulative BOE pandemic monetary stimulus/notional liquidity is almost 53% of Britain’s 2019 (pre-COVID) nominal GDP.
The UK10Y bond yield is currently trading around +1.16%; it made a low of around 0.226% in July’20. BOE is very conservative for QE while using NIRP jawboning to keep U.K. borrowing cost as well as currency (GBP) lower or rather than at an ideal level in a balancing act. But BOE has to control inflation to control bond yield/borrowing costs. The U.K. now pays around 4.5% of its revenue as public debt interest against U.S.’ 9.5%; looking ahead, the U.K. has to keep this ratio under 5% or 3.5% pre-COVID levels. Thus, BOE has to act in a balancing way to keep GBP and bond yield at an equilibrium way to control imported inflation, boost export and keep government borrowing costs at lower levels.
Surging oil/energy prices and elevated COVID cases, some vaccine hesitancy (despite the excellent rate of vaccinations) may affect the economy and currency going forward. BOE Governors traditionally often jawboned the market with a bazooka, but ultimately comes with a water pistol. This time we may see the same drama too. The BOE may go for QE tapering from Nov’21 and then go for liftoff after H1CY22, when employment returns to pre-COVID levels. Meanwhile, BOE will continue to jawbone the market to control inflation and inflation expectations.
Technically, whatever may be the narrative, GBPUSD now has to sustain over 1.38500-1.39100 for 1.4000-1.42500; otherwise, it will correct again towards 1.33900-1.30900.
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