BoE preview: Hawkish hold

We change our call and no longer expect the Bank of England (BoE) to increase the Bank Rate at the MPC meeting on 10 May. We think a rate hike will be postponed to the next big meeting in August. In this sense, it is going to be a hawkish hold given the relatively subdued market pricing of future BoE rate hikes. We raise our 1M and 3M EUR/GBP forecast to 0.88 in 1M (previously 0.8650) and 0.8650 in 3M (previously 0.86). We keep our 6M and 12M forecasts unchanged at 0.84 and 0.83, respectively.
	Hiking cycle postponed, not cancelled Many UK economic indicators have surprised on the downside recently and hence we no longer expect the BoE to increase the Bank Rate at next week’s meeting. One of the reasons why we believed the BoE would move in May and not August was due to the high market pricing, but it feels like a long time ago that a May hike was a sure thing. Inflation is lower than the BoE projected in February, GDP growth was only 0.1% q/q in Q1 (below the BoE’s estimate of potential growth of 0.25% and the expectation of 0.3%) and the PMIs for April were not encouraging. Not all indicators are speaking in favour of postponing a rate hike though. Unemployment has dropped to 4.2% from 4.4% at the time of the last meeting and the BoE is already concerned about excess demand, as it is around the current NAIRU estimate of 4.25%. Wage growth (as measured by average weekly earnings ex-bonuses) is also still increasing at a reasonable pace. While we no longer expect the Bank of England to hike next week, we do not think this is the same thing as the hiking cycle being cancelled altogether and we think the BoE rate hike will be postponed to the next big meeting in August, which would be the only one this year. In this sense, it is going to be a hawkish hold, as the bias it towards increasing the Bank Rate (remember, two voted for a hike in March). As Mark Carney & co have highlighted they are data dependent, it makes sense to wait for further data before hiking. Q1 GDP growth was weak but the initial estimate was lower than indicators such as PMIs suggested and we would not be surprised if it is revised up to 0.2% q/q from 0.1% q/q, as we get more information. We also expect growth to be slightly higher later this year although still weak compared to European peers. As mentioned, the unemployment rate has actually moved below NAIRU and is still likely to fall further; therefore, the BoE is still likely to signal that it expects higher wage growth going forward. We expect an unchanged 7-2 vote count. We have also changed our call for next year and now only expect one additional hike next year (down from two previously), probably in May 2019. This makes sense, as the BoE will not tighten monetary policy too much relative to the ECB, which we now expect to stay on hold until December 2019. The biggest source of uncertainty is still Brexit and how it may impact the economy. FX outlook: we revise 1-3M EUR/GBP forecast higher, but still expect the cross to break lower 6-12M EUR/GBP has bounced substantially over the past weeks after BoE Governor Carney casted doubt on a rate hike in May and as rate hike expectations have subsequently declined on the back of weak UK GDP and PMI data. With the BoE rate hike now most likely postponed until August, we see risks skewed moderately to the upside for EUR/GBP going into the BoE meeting on 10 May, and we raise our 1M and 3M forecast to 0.88 in 1M (previously 0.8650) and 0.8650 in 3M (previously 0.86). Market expectations of future rate hikes are very modest, with only 15bp priced in for August (60% probability) while the first full 25bp hike is priced in by January 2019. Hence, if we right in our call of a ‘hawkish hold’ and an ensuing hike in August, relative rates should not be a significant driver for a higher EUR/GBP in the short-term. Our short financial model suggests that EUR/GBP might bounce 0.25-0.50 figures in case of a 10bp narrowing of the 2Y swap interest rate spread between the UK and the EU. Hence, EUR/GBP could temporarily break above 0.8850 and potentially test 0.89 before the meeting or on the announcement. Longer term, Brexit still remains a key driver for GBP and while uncertainty remains high, we still expect EUR/GBP to eventually trade lower driven by Brexit clarifications and fundamental valuations. The turn in capital flows and FDI flows back into the UK, as indicated in the latest balance of payment data, suggests that a key headwind to GBP seen in Brexit is reversing, supporting the case for additional GBP appreciation over the medium-term. We target EUR/GBP at 0.84 in 6M and 0.83 in 12M (0.84).