See important Research Disclaimer.
On Thursday 14 July, Mark Carney will present the conclusions of a monetary policy meeting which went from irrelevant to the most hotly anticipated event of the week. The dovish comments from Mark Carney after the referendum were stark, with the governor announcing that ‘some monetary policy easing will likely be required over the summer.' There is no guarantee we will see the committee move this month, yet with markets now pricing in a 79% chance of a 25 basis points cut, there is reason to believe that a cut is largely priced into markets.
Interestingly, markets seem to have made their mind up on this one, with a 0% chance that the BoE will cut by 50 basis points (to 0%) and only a 21% chance that the committee will retain the current 0.5% rate. Considering BlackRock today came out with a base case scenario of a 50 basis point cut, there is reason to believe that this incredible degree of certainty could be somewhat misplaced.
The Bank of England (BoE) has traditionally used two major tools for easing monetary policy; interest rates and asset purchases. The BoE asset purchase programme bought a total of £375 billion assets, helping spark a FTSE bull market as fixed income investors moved out of bonds and into stocks as a result of the depressed yields associated with QE.
This form of easing is no doubt the holy grail for investors, sparking hysteria over the market implications once a new bout of QE is announced. That being said, this is typically a form of easing which is saved for desperate times, which arguably could later in this story. Any action is likely to be preemptive rather than in response to any particular economic data given the brief period between the referendum and this meeting.
As such, QE bazooka is likely to be held back for now. That being said, should we see the committee introduce another bout of QE, we would expect gains for stocks, a weaker pound and further downside for Bond yields.
There is still a good chance we could see the BoE stay put on Thursday, choosing to hold off until August. Interestingly, the August meeting also includes an inflation report which means the committee could wait until that meeting to see the post-referendum growth, inflation and employment data before acting.
The impact of cutting the headline interest rate would likely be a devaluation of sterling alongside greater investment through disincentivising savings. Crucially, the devaluation of the pound would be seen as a driver of investment both from abroad and domestically as UK goods and services are comparatively cheaper.
However, with GBP/USD having recently hit a 31-year low, there is reason to believe this aspect is arguably less important than in the past. Given the resolution of the UK leadership contest, we have seen a significant degree of uncertainty removed for now, with Theresa May set to move into Downing street on Wednesday.
With that in mind, there is reason to believe the committee may wish to stabilise the pound, thus providing a calmer environment amid all the recent volatility. Should the MPC keep rates at 0.5%, we are likely to see a sharp appreciation for sterling, coupled with a pullback in stocks.
This is of course the most likely eventuality, with markets expecting a 25 basis points cut (80% expectations). The degree to which the committee cuts would likely be the determinant of subsequent price action, with anything less than 25 basis points risking a rally in sterling and losses for stocks.
There is no doubt that much has been factored into markets already, which means those chasing post-presser moves should be aware that sometimes markets appear to be contradictory to economic theory. With that in mind, there is a chance that a cut of more than 25bp would be required to really have a lasting effect.
Make no mistake, the language surrounding any announcement is just as important as the announcement itself. As alluded to earlier, it is likely the BoE will wish to hold back QE for future dates, yet the ability to notify markets that it is an option in the future means that we could see a volatile market reaction.