BOE: have the doves flown the nest?

This week the markets have been impacted by three main factors: firstly, another decent week of corporate earnings for Q2, secondly, the Bank of England meeting and lastly, an update on the state of the US labour market. The BOE did not fail to disappoint, there was a notable shift in tone to the hawkish side from the Bank, who said that some “modest tightening” would be necessary to keep inflation in check over the next two years. This is another sign that the BOE is pulling ahead in the central bank stakes, with the UK’s central bank likely to be the first of the major central banks to start tightening interest rates. While the FTSE 100 suffered a modest decline immediately after the BOE meeting, we believe that the Bank’s message should be welcomed by FTSE bulls, and the outlook for UK assets remains bright. In terms of the US labour market, the world is holding its breath to see what NFPs come up with for July, after a deeply disappointing ADP private payrolls report gave markets pause for thought.

A dovish-hawkish shift at the BOE 

The BOE meeting came at an interesting junction for financial markets. Some of the twitterati have been angrily posting about double standards in the stock market, with stocks climbing ever higher no matter what is thrown at them. You get the sense that some traders want another major bout of volatility to drive their portfolio returns higher. If you want volatility, we continue to point you in the direction of Bitcoin, which, let’s face it, is a trader’s dream. Instead, we would argue that the BOE is managing a dovish-hawkish shift in direction, which could supress market volatility even more and which should not disrupt the global rally in risky assets. What do we mean by dovish hawkish? Well, although a majority of BOE members agree that the economic conditions have been met to discuss the need to taper asset purchases, they are in no rush to do so. The committee voted 7-1 to continue with its £150bn asset purchase programme, which expires at the end of the year. Added to this, the BOE’s own interest rate forecasts show only a gradual increase in interest rates, with one increase of 25 bps coming next year and another in 2024. Of course, there is the risk that forecasts could be upgraded, but inflation was revised significantly higher to 4% by the end of this year, the previous forecast was for inflation to peak at 2.5%. The BOE now expects inflation to remain elevated into next year due to excess demand over the next 12 months. 

One lone hawk spotted on Threadneedle Street 

Thus, the BOE has managed a tough balancing act – they know that it would be shirking their responsibilities to fulfil their mandate of controlling inflation by ignoring price rises à la Federal Reserve, but they also know that they can’t rock the boat or get too far ahead of the rest of the global central bank pack, as that could be bad for the UK’s economic recovery. Instead, the BOE managed to talk tough, but not too tough, and to signal that rates would rise, but not by much. Also, there was some expectation that there would be a 6-2 split, with 2 members of the BOE expected to vote to immediately to reduce the size of the BOE’s QE programme.  In the end, only one member, Michael Saunders – a long term hawk, voted against the majority of the BOE who voted to keep asset purchases at their current rate. 

Interest rates for starters, then tapering for main is the BOE’s plat de jour  

As a way to fulfil their mandate without spooking financial markets, it was a masterclass by the BOE. The Bank shifted its pre-conditions for tapering asset purchases. Usually, it’s taper first then raise interest rates later. The BOE has turned that method on its head. It said that it would only start to reduce its stock of bonds when interest rates reach 0.5%, by not reinvesting the proceeds of maturing debt, and it would only actively sell down holdings when interest rates reached 1%. This suggests that the size of the BOE’s balance sheet is not going to change for at least a year, and that the BOE’s monetary stimulus will remain in the UK’s money supply for some years’ yet. In our book, today’s meeting was “hawkish”, without being hawkish at all, and it’s clear that financial markets did not buy the BOE’s hawkish spiel either. The pound is up slightly at 0.35% today, but it remains stubbornly range-bound versus the US dollar. For GBP/USD, $1.40 remains a tough level of resistance to overcome, while in EUR/GBP the downtrend will be tested by the market when it reaches £0.8470 – the low from April. If this level is broken, then we could see a sharper decline all the way back to £0.7290. 

GBP/USD and $1.40 

Overall, we think that the outlook for stocks remains strong, as global corporate profits for Q2 continue to beat expectations. The risk of the delta Covid variant, that threatened the global uptrend in developed stock markets, is also starting to recede. Even though case numbers are rising, particularly in the US, the death rate is stable, meaning that future damaging economic lockdowns look less likely at this stage. Whether or not we see GBP/USD shoot through $1.40 will be dependent on the outcome of the NFP report for July, which is released this Friday. The market is looking for 870k, which would intensify speculation that the Federal Reserve will use this month’s Jackson Hole central bankers’ symposium to inform the market about its tapering plans. Earlier this week, a disappointing ADP private sector payrolls report was balanced out by some Fed officials who said that tapering was the next act in the Fed’s playbook. Overall, a weak payroll report at the end of this week, could make it difficult for the Fed to stray from its dovish mantra in Jackson Hole later this month, and it could give the opportunity for GBP/USD to break the $1.40 barrier. If that happens then it may give us a fighting chance to be correct that the pound would end up the strongest performer in the G10 this year! 

Oil’s bearish bounce 

Interestingly, while global stocks have been fairly sanguine about the rise in the Delta variant Covid cases around the world, aspects of the commodity market are freaking out. The benchmark crude oil price fell 6% this week to just over $70 per barrel. While we do not think that the markets need to fret about the Delta variant, as mentioned above, we explain the oil price dive this week as a sign that the long-term trend in oil remains downwards. This year’s amazing recovery rally was a bounce in a bear trend from a technical perspective, hence when oil breaches the $75-$77 per barrel mark downward pressure starts to build. Even with Brent’s mini recovery on Thursday, which saw the price jump back above $70 per barrel, we imagine that oil will remain range bound between $70-$75 in the medium term, and larger gains could be made elsewhere, for example in developed market stock indices. 

Charting the oil price through the years