GBP: BoE rate rise would be negative? – HSBC

Analysts at HSBC do not think a BoE rate hike would be GBP positive as in a cyclical world, rate hikes are currency supportive, but in the structural and political world that GBP inhabits, they believe rate hikes could be damaging.

Key Quotes

“There is a clear divide within the Bank of England. Concerns over rising inflation have exposed a hawkish and a dovish camp. This has opened the door to the possibility that the BoE could hike rates in the near future. Indeed Governor Mark Carney’s very recent hawkish comments have added an extra notch to the debate. By explicitly stating that “some removal of monetary stimulus is likely to become necessary”, this indicates a rate hike is not just possible, but might even be probable. We believe it would be a mistake to hike rates in the UK at this juncture and do not believe a rate hike would cause a sustained rally in sterling.”

“Those who advocate a rate hike believe the combination of high inflation and low unemployment – two cyclical considerations – warrants action. But even in the cyclical world, the case for rate hikes is not clear cut – a lot of economic activity data (e.g. wage growth, retail sales) have disappointed in recent months.”

“Moreover, we believe the dominant issues for the UK are structural and political in nature. GBP’s weakness in the last year should help an economic transition, causing higher imported inflation and a squeeze in real incomes, thus leading to narrower trade and current account deficits. But the process is far from complete. Additional, albeit gradual, depreciation is required to rein in these imbalances.”

“In a normal cyclical world rate rises are a reason to buy a currency. Indeed the trained behaviourist reaction to a rate rise may be initially positive for GBP. However, Brexit puts us a world away from cyclical normality. We believe hiking rates in this environment might risk exacerbating consumer retrenchment at a time of heightened political uncertainty. This could induce a more vicious downturn and might cause GBP to fall even further. A reaction function of higher rates and a weaker currency occurred in Russia during 2014. There are lessons to be learnt from this experience.”

“We continue to believe that GBP is headed to 1.20 against the USD and to parity against the EUR by year-end. The last thing the UK needs in our view is an unnecessary rate rise being added to the already difficult economic and political outlook.”