The pound may have recovered above 1.5100 as we move into the UK lunchtime session, but this morning’s data was clear: the UK’s interest rates are unlikely to increase any time soon. The main points from the BOE minutes released earlier today:
- Oil prices have won out over wage growth – although wages climbed to their highest level in 2 years and the unemployment rate fell to its lowest level since 2008, the falling oil price is still stoking deflation fears at the BOE.
- There is a real risk that UK CPI could turn negative in the first half of this year.
- McCafferty and Weale, the former dissenters, have flip-flopped back to the majority, and now all 9 members of the MPC want to keep rates on hold.
- This suggests that the decline in price pressure has raised the bar for a rate hike in the coming months and we now do not expect the BOE to raise rates at all in 2015.
What this means for interest rates:
The 2-year UK Gilt yield has fallen to its lowest level since August 2013, this means that the last 18-month’ worth of expectations about a rate increase from the BOE has been wiped out. If you remember back to August 2013, the prospect of a UK rate rise was on the back burner and the economy was still on shaky ground.
Although the economy is on a more stable footing now, the inflation picture is the game changer. The 2-year Gilt yield tends to move in line with interest rate expectations, and its weakness to an 18-month low of 0.36% suggests that the bond market believes that the BOE will remain on hold for some time.
The GBP impact:
The pound is the weakest performer in the G10 FX space so far today, and it is struggling most against the NOK, which is on the rebound after a sharp sell-off, and the JPY, which is attracting safe haven flows. Since we believe that it is the BOE minutes and the prospect of a delayed rate hike that is driving the pound lower, it is worth taking a look at interest rate spread analysis.
The UK-US 2-year yield spread had fallen to an 8-year low of -0.14% in late December. However, at the start of the year the spread started to widen, although it didn’t manage to break back into positive territory before falling sharply in the last couple of days.
As you can see, GBPUSD follows the 2-year yield spread closely, and if this stays close to its 8-year lows for the long-term then upside potential in GBPUSD could be limited.
From a technical perspective, GBPUSD remains in a long-term downtrend. In the short term it remains in consolidation mode, and is trading in a range between 1.5035 – 1.5274. A break below 1.5035 – the low from earlier this month – could open the door to a more protracted loss back to 1.4814 – the low from mid-2013.
Figure 1:
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