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Bank of England the main focus as oil prices head towards $80

The FTSE 100 had another strong day yesterday, helped in no small part by the continued rise in the oil price, as well as the US dollar.

The strength of the US dollar also appears to be helping European markets continue to recover some of the lost ground from earlier this year, with the DAX moving back to within touching distance of the 13,000 level for the first time since February.

The rise in the oil price, now up over 50% since September last year, hasn’t as yet prompted a re-evaluation in this year’s economic forecasts but as can be seen from recent weak consumer data, in Europe, the UK, as well as the US, it could well be starting to have an effect in some of the more recent retail sales numbers. Paying more to fill up your vehicle leaves a lot less room for those consumer discretionary items. 

If oil prices move above $80 a barrel, as seems likely given recent events with the Iran nuclear deal, as well as unrest and upcoming so-called elections in Venezuela, this could well cause further headaches for policymakers, if the global economy were to slow on the back of these price rises.

Up until a couple of weeks ago it appeared inevitable that we would see a rise in UK rates of 25 basis points to 0.75%, which would have been the first time that rates would have shifted above 0.5% since they were slashed to their current levels in 2008.

The original catalyst for this shift in tone wasn’t any significant decline in economic data, though there were clues it was starting to soften a little and has done so a little bit more in the last two weeks. The catalyst came from comments from Bank of England governor Mark Carney who indicated that a move this month wasn’t the done deal that many thought it was.

This was a significant change of tone from the optimism that we saw in the Bank of England inflation report in February and subsequent comments since then. This failure on the part of Bank officials to soften this guidance as some of the recent data weakness became apparent is part of the forward guidance problem the central bank has, and not for the first time.

In 2014 they showed similar shortcomings and once again their ability to guide market expectations is once again being questioned. It is an ability that the ECB and Federal Reserve appear better able to manage, and something the Bank of England needs to manage better. Saying that rates will rise sooner than markets expect is usually a decent signal that a rise is coming.

If you retain the flexibility of being data dependant you keep market expectations in check, but to keep promising a course of action and then failing to deliver is not a good look. It saps confidence in credibility and that is an area that the Bank of England really needs to work on.

While interest rates are now expected to be left where they are, at 0.5%, it is also quite likely that the Bank may well have to guide its growth expectations lower, given that today’s March industrial and manufacturing production data for March is likely to reinforce that economic weakness, though most of it is likely to be cold weather related. Inflation expectations could also be revised lower, which in term could see the pound come under further pressure.

This isn’t something the bank will want in terms of drilling down on inflation, which is now starting to come down, so the guidance will need to be carefully balanced in order not to upend the pound too much. This is something that Mr Carney hasn’t always been particularly good at, while the votes of Saunders and McCafferty will also be scrutinised.

Will they remain wedded to their calls to push rates up, despite the softer data, and what do policymakers make of the recent surge in the oil price and its impact on the growth outlook, as well as the inflation outlook?

Recent data from elsewhere across the globe has seen inflationary pressures remain subdued with last week’s EU inflation still well below target, Chinese CPI slipping to 1.8% this morning, while US inflation appears to be starting to show signs of finally moving above the Fed’s 2% target level.

Forex snapshot

EUR/USD – the break below the 1.1920 area has opened up a test of the 1.1780 level, as well as the December lows at 1.1710. This 1.1920 area should now act as resistance on any pullbacks, and as such we could see further declines towards the 1.1500 area in the medium term. The fall below the 200 day MA shifts the calculus towards the downside.

GBP/USD – so far able to hold above the 1.3480 area and 200-day MA, but we need to move back above the 1.3630 area to stabilise. A failure to do so invites further losses towards the 1.3300 area in the medium term.

EUR/GBP – last week’s failure above the 0.8830 area has seen the euro slip back and invites the possibility that we could revisit the 0.8680 area, as well as the April lows at 0.8610. 

USD/JPY – looking to retest the resistance at the 110.00 level with key resistance up at the 200-day MA at 110.25, with trend line resistance at 110.50 behind that. Support remains back at the 108.70 area. A move beyond 110.50 opens up the 112.00 area.

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