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Gloomier BoE to Weigh in on U.K. Economy

The Bank of England (BoE) will publish its quarterly Inflation Report on Wednesday. The market will look to the report to try to piece together the central bank’s interest rate hike timetable. Also of interest will be the BoE’s thoughts on European growth as several countries will publish their preliminary gross domestic product (GDP) numbers on Friday.
Currently, U.K. inflation is at 1.2%, a five-year low. The biggest threat to the U.K. is lower price growth as it could further delay an interest rate hike. Energy and food prices were the biggest drivers of lower inflation. The U.K. central bank was upstaged by an accelerating economy that raced ahead of forecasts. That understandably led to concerns the BoE might miss estimates in the other direction.
The U.K.’s Economic Quandary
The U.K. economy is slowing down, and while initial estimates had Governor Mark Carney raising the U.K.’s rates earlier than other central bankers, it now seems Chair Janet Yellen at the Federal Reserve will have that honor. Statements from the BoE’s Monetary Policy Committee (MPC) members have talked down the possibility of a rate hike this year, and the expectation has been pushed until after the island’s federal election in 2015.
The BoE’s forecast will most likely be cut following the dovish statements from the central bank’s chief economist Andrew Haldane, as the mood inside the MPC seems to have cooled somewhat after softer economic indicators of late. In the previous report, the growth forecast for this year was 3.5%, 3% in 2015, and 2.6% in 2016. This year could be cut down by a couple of percentage points given current global economic conditions.
European Growth Remains Elusive
A big risk for the British economy is the lack of growth in Europe. While the U.K. has positioned itself along the U.S. on a fast track toward full recovery, Europe has joined Japan in the dangerous deflationary zone. The Bank of Japan made shockwaves last month when it suddenly increased the size of its bond-buying program designed to stimulate growth. The European Central Bank has its hands tied given the collaborative nature of the European Union’s government. Member nations have to agree on such massive-scale decisions, and in this case, Germany stands against using conventional monetary policy stimulus, meaning the ECB has to resort to “alternatives” and possibly less effective mechanisms.

The release of the BoE’s Inflation Report holds a mixed bag for the GBP/USD. Lower inflation expectations will be shared in the short term given the overall lower costs of food and energy due to the fall in commodity prices. Prices are expected to rise in the future, which could coincide with the BoE’s plans to raise rates, but analysts expect them to wait until well into 2015. Lower interest rates for longer with a Fed on a clearer path could boost the U.S. dollar against the pound.

On the other hand, if growth forecasts are not cut or not as deeply given the resilience of the U.K. economy, and especially when compared to the E.U., the confidence of the central bank can translate in to pound strength. That, in turn, could carry over to Friday when the E.U.’s preliminary GDP numbers are posted.

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