This week’s PMI data for July was as disappointing as most people suspected it might be with business confidence, optimism and consumer confidence being hit particularly hard in the wake of the June Brexit vote.
This shouldn’t be too much of a surprise given the warnings of economic Armageddon that were a core theme of the campaign to remain in the event of a vote to leave, although the political turmoil in the aftermath wasn’t exactly helpful either.
Despite this political turmoil, which has now passed the Bank of England’s response was timely and effective, as the pound dropped sharply in response to the calm and measured response of Bank of England governor Mark Carney in calming markets and adding liquidity so that financial markets didn’t seize up in the aftermath.
The resulting fall in market rates has helped financial markets recover quite nicely in the days and weeks since then, which means that the Bank of England needs to maintain its measured response when it delivers its verdict on base rates, as well its outlook for GDP and inflation in its August inflation report.
While it is widely expected today that the Bank of England will lower its growth forecasts it is also expected to make a move on interest rates for the first time since 2009, and cut rates by at least 25 basis points to a new record low of 0.25%. It could also go on to announce the intention to implement further asset buying programs, however there is a school of thought that suggests the Bank should hold firm and wait and see.
This is because there is a widespread acknowledgement that any such action today will probably not make a blind bit of difference and could well make things much worse, not only for banks, who are already struggling with wafer thin margins, but also for pension funds who are struggling with spiralling deficits, while savers continue to struggle with meagre returns.
Indeed Charles Bean an ex Bank of England policymaker acknowledged that fact earlier this week, calling for a greater symmetry of response between fiscal authorities and the Bank of England.
The reflex reaction of central bankers to any crisis over the past few years has been to cut rates and buy assets to head off, or soften any economic shock to the domestic and global economy. While that may have proved to be an effective response when interest rates were at 5% it becomes much less effective when interest rates are at 0.5%, which is where we are now.
To delay or defer any action would be a major surprise, which is why they probably will act on rates at least today, but it would also be an acknowledgement that monetary policy alone is unable to offset the structural problems of the UK economy which have always been there, but could become more acute in the absence of further fiscal and structural reforms.
In this vein the guidance will be as important as the decision itself, in the context of the next move on the yield curve, particularly if the bank is overly dovish.
The experience of banks in Europe and Japan should be a lesson to central bankers here in the UK that low and negative rates have been a disaster laying bare for all to see the soft underbelly of the problems in the European banking sector.
In fact recent easing measures by both the ECB and Bank of Japan have failed to generate the desired response from markets that policymakers had intended, which is a warning in itself that monetary policy is starting to reach its limits.
Knowing all of this and the fact that the UK government have decided to wait until the Autumn Statement to formulate its fiscal response, in order to get a clearer picture of recent events and their effects on the UK economy, surely it would make more sense for the Bank of England to do the same, and with that in mind we might get an announcement to that effect, that further measures were contingent on future events.
This would make a refreshing change from the economic groupthink of recent years which has seen policymakers react the same way with very little evidence that their policies have had any other effect than boosting asset prices and hollowing out savings.
EURUSD – yesterday’s failure to overcome the 1.1250 area has seen the euro fall back but as long as we stay above 1.1100 the upside remains intact. We need a move beyond 1.1250 to open up a retest of the June highs at 1.1400.
GBPUSD – having peaked at 1.3372 yesterday we need to see a move through 1.3420 to suggest a retest of the range highs near 1.3500, and beyond. Trend line support from the lows this year, now at 1.3170 continues to support the current up move, with a move below opening up the 1.3050 area.
EURGBP – having seen support at 0.8410 give way the risk of a move towards 0.8260 comes into focus, if we break below trend line support at the 0.8350 level. A move back through 0.8430 is needed to reopen the recent highs at 0.8490.
USDJPY – has found support at the 100.60 level over the past day or so but needs to recover through the 103.50 area to stabilise. The risk remains for a move back towards the lows at 98.90 on a break below the July lows at 99.99.
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