From Hawks To Doves In A Swoop

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Unexpectedly, for most people, at least the Bank of England has changed it's long held hawkish stance to a dovish one. From a policy point of view, move makes economic sense and should therefore not have been entirely unexpected. In fact, Bank of England had looked like an exception to the more dovish stances taken by most other major central banks in recent months. The May Inflation Report signalled a very gradual path of higher rates, conditional on a smooth Brexit outcome and a somewhat upbeat view of the global economy. In contrast, recent comments from US Federal Reserve officials suggest that the door has been opened for a rate cut as early as the next meeting on 31 July. The ECB, meanwhile, could prepare the ground at their next meeting on 25 July to reduce rates further into negative territory in September.

In the coming week, analysts expect to see a strong rebound in UK May GDP (Wed) of 0.4%. It declined by the same magnitude in April, as a result of a plunge in car production as manufacturers brought forward their usual summer shutdown to the period just after the original Brexit deadline. Some of the other subsectors of manufacturing were also weak, while services output was flat and therefore provided no offset. Still, the forecast for a rebound in May GDP, facilitated by a bounce in car production and a small rise in services output, would lead to a fall in the rolling three-month growth rate to 0.1%. For Q2 as a whole, the BoE currently expects GDP growth to be flat, but the arithmetic ‘carry-over effect’ looks set to be positive in Q3 meaning that flat monthly outturns would still result in positive growth for that quarter. Nevertheless, in light of rising domestic and international risks, BoE MPC members Silvana Tenreyro (Mon), Gertjan Vlieghe (Wed) and Governor Carney (Thu) are scheduled to speak.

On the political front, postal votes for the next Conservative leader take place in the coming next week. Boris Johnson and Jeremy Hunt will take part in a number of events, including a TV debate on Tuesday.

The minutes of the ECB’s 6 June policy meeting (Thu) will be scoured for confirmation that officials are moving towards further stimulus. The ECB pushed out its rates guidance to mid-2020 for the earliest increase, but President Mario Draghi revealed at the press conference that several members raised the possibility of rate cuts and a restart of QE. Less than a fortnight later, at a forum in Sintra, Draghi was more forthright in expressing his view that “further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools”. A plausible scenario is that the ECB alters its guidance again in July to introduce a reference to the possibility of lower rates, setting up a reduction in the deposit rate (currently -0.4%) in September by as much as 20bps. The tiering of interest rates could be implemented to mitigate the impact of negative rates on the profitability of banks, mainly those with stronger deposits in northern Europe. The possibility of restarting QE has been signalled, although the bar to such an outcome is higher. A significant weakening of the growth and inflation outlook would increase the likelihood of more QE by the end of the year or early next year. Draghi said that the limits to the asset purchase programme “are specific to the contingencies we face”, suggesting that the ECB’s purchasing limits (33% for each bond issue/issuer) could be relaxed. The current IMF chief Christine Lagarde supported the ECB’s original QE policy, and her nomination to take over at the ECB after Draghi departs in October reaffirms the potential for more QE.

Eurozone industrial production figures for May (Fri) may show a small rise and would support expectations for overall GDP growth to have weakened in Q2. The Eurozone figures will be preceded by national releases including from Germany (Mon), France (Wed) and Italy (Wed). Greece holds elections this Sunday. Elsewhere, the Bank of Canada (Wed) is expected to keep policy rates on hold at 1.75%, while Chinese data releases include trade figures (Fri).

See you next week! To discuss how the above may affect you, please contact your Currency Dealer at Heritage Pay on +44 (0) 203 858 7274.

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