Viraj Patel, Foreign Exchange Strategist at ING, suggests that with the Fed and ECB on a distinct path of policy divergence, the BoE have been caught in limbo when contending with the impact of powerful, albeit conflicting, spillovers from policies abroad.
“Though an ECB rate cut will predominantly weigh on the domestic rates of European economies, that the Fed spill over effect has remained the more prominent channel for UK rates (though the gap did narrow considerably during the heightened risk-off period in 3Q15). But the latest decline in co-movement with US rates serves to highlight the BoE’s frailties when navigating between the two offsetting storms.”
“More recently, most of the MPC have refrained from matching the Fed’s strong hawkish bias and have instead opted to side with the ECB’s more cautious stance on global headwinds (ie, weak EM growth and bearish commodity price outlook). Consequently, the start of the BoE hiking cycle remains priced in for early 2017; this seems at odds with the constructive domestic story and we see the risks skewed towards a hawkish re-pricing given that our economists are looking for a 2Q16 BoE rate hike.”
“We think the BoE will be more tolerable of near-term GBP strength stemming from any 2016 liftoff should we see the following: (i) another uptick in wage growth; (ii) oil prices stabilising and beginning to gradually recover; and (iii) an ongoing divergence in GBP’s performance against its two major trading partners (USD and EUR). . In a year that is likely to be plagued with external headwinds, the first factor will remain the most powerful justification for the MPC to begin its tightening cycle. There is a greater likelihood for this positive wage growth story to emerge in the 1H16 data.”