January 25th 2012: Preview - Bank of England edges away from the abyss
The UK economy will be braced for bad news on Wednesday with the possibility that GDP contracted during the fourth quarter. The Bank of England minutes may receive less attention initially given the media focus on the GDP number, but they are actually more important overall and they should help Sterling recover from any initial losses. Overall, look to buy Sterling on any spike lower following the release.
The practical difference between a figure of +0.1% and -0.1% is very limited, especially as the data will be revised substantially over the next few months. Nevertheless, there will be a fresh media frenzy surrounding recession if there is a quarterly contraction. In this context, Sterling is likely to spike following the data with a sharp fall if there is a quarterly decline, especially if it is more than 0.1% while any figure above zero will trigger immediate relief.
The Bank of England minutes will be released at the same and there is a very strong probability that there were 9-0 votes to keep interest rates and quantitative easing on hold at the latest policy meeting. There has been a notable shift in Bank of England rhetoric over the past two weeks and this is likely to be reflected in the minutes. In comments on Tuesday, MPC member Posen stated that the downside risks to the economy had eased. There were similar comments from Bank of England Governor King in a speech late in the day. The comments from King late last year were notably fearful in their tone as the banking sector lurched towards a major crisis. King was certainly still concerned on Tuesday, warning that the economy was facing headwinds, but the tone was notably lighter. He stated that there was ‘no reason to despair’ and that ‘all crisis come to an end’.
Cynical observers would look at the Bank of England’s recent track record and suggest that when the bank is feeling more confident over the outlook then it is time to get really worried. It is certainly difficult to construct a longer-term bullish scenario for Sterling given the debt profile.
It is also the case that the central bank is still prepared to launch additional monetary easing if necessary. King, for example, stated that slower inflation gives policy makers room to increase bond purchases to aid the UK economy and guard against a renewed severe downturn. Nevertheless, the sense of doom surrounding the bank seen late last year has certainly eased as the aggressive ECB operations to boost liquidity have had an important impact in easing credit strains and this will help underpin Sterling in the very short term. The Bank of England is also likely to be less aggressive in any near-term additional quantitative easing.
Given the bank’s likely tone, there is scope for Sterling to gain ground on the minutes. In this context, there should be scope to buy Sterling after any knee-jerk fall following the GDP data.
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