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The pound dropped a full 1% as Carney was speaking and the yield on UK Gilts dropped into negative territory for the first time. Speculation is high that UK interest rates could eventually be cut from their current 0.5% all the way to zero, but Carney’s scepticism of negative interest rates have many also believing that asset purchasing quantitative easing could return. It is this particular speculation that seems to have helped the FTSE add another 1% in its last hour of trade. And the prospect of a return to QE in the UK seem to have been a boon for US markets as well with the S&P 500 rallying 1.3% to almost close above that key 2100 level.
Of course, at the same time as markets were responding to UK stimulus hopes, UK politics took another dramatic turn with Boris Johnson, the front-runner to take over from David Cameron, pulling out of the leadership race. This comes in the wake of Michael Gove’s wife “accidentally” leaking to the press that Rupert Murdoch and Daily Mail editor Paul Dacre didn’t believe in Boris Johnson, which was soon followed by Gove announcing his candidacy for the leadership. And now Theresa May and Michael Gove are the favourites to win the battle to become the next Prime Minister, with May the bookies favourite.
The key takeaway is that both May and Gove seem committed to taking the UK out of the EU single market, which is what will do the most damage to the UK economy and largely guarantees Scotland will leave the UK. Markets seem to be focused on the short-term in that these potentially devastating economic consequences will warrant further monetary stimulus, rather than that it will have negative economic consequences. Unfortunately, years of QE-induced equity market performance has developed the opposite response to negative economic developments, and that very much seems to be driving market performance at the moment.
But the pound seems to be a far better reflection of the expectations for the UK economy. And while markets haven’t really encountered massive jumps in inflation alongside QE policies, the massive drop in the value of the pound will change this calculus in the UK. The explosion in tradables inflation in the UK will likely put the BOE in a much more difficult place than markets are currently assuming, as their goals to control inflation and support the economy start to become diametrically opposed.