G10 FX Weekly: BoE Opens Downside for UK Short-End Yields and GBP

Summary

• The Bank of England (BoE) left rates unchanged yesterday but shifted towards a cut as early as next month.
• The Monetary Policy Committee (MPC) voted 7-2 in favour of the hold, with two dissenters (including Deputy Governor Dave Ramsden) calling for an immediate cut.
• Governor Andrew Bailey was notably dovish on market pricing in the post-meeting press conference.

Market Implications

• We think the BoE is now more likely to cut rates faster than market pricing, even as early as next month.
• We expect UK short-end yields and GBP to fall in coming weeks.

The BoE Tilts Dovish

Although the BoE kept rates unchanged yesterday, the MPC’s messaging was decidedly dovish.

First was the shift in the vote count. As before, external MPC member Swati Dhingra voted for an immediate rate cut again – no surprise given she is the most dovish MPC member.

More importantly, however, Deputy Governor Dave Ramsden, one of five internal MPC members, also voted for an immediate rate cut. This is notable because the internal MPC members often vote as a bloc.

A dissenting deputy governor could signal other internal MPC members are more likely to follow Ramsden in voting for a cut soon.

Perhaps most important, however, were BoE Governor Andrew Bailey’s post-meeting comments to the press on market pricing of BoE rate policy. Bailey said ‘it’s likely that we will need to cut bank rate over the coming quarters … possibly more so than currently priced into market rates.’

It is rare, and we believe significant, for the governor to be this aggressive about market pricing.

This Dovish Tilt Means Lower UK Short-End Yields

The shift in MPC voting, together with Bailey’s comments, opens additional downside for UK yields in the coming weeks and months.

Market expectations for a rate cut on 20 June edged higher after the BoE presser, from a 47% probability of a 25bps cut to 57%.

We see room for that probability, and the probability of additional easing later this year, to rise. As such, we think UK short-end yields will fall further.

Using the 2-year gilt yield as a proxy for the short end, we expect a revisit of the year-to-date low just below 4% in the coming weeks (Chart 1).

Chart 1: 2-Year UK Gilt Yield = Orange Line

Further US Short-End Yield Drop Could Drag UK Yields Lower

So far this month, the US 2-year yield has fallen over 20bps (Chart 2).

Chart 2: 2-Year US Treasury Yield = Orange Line

We think US short-end yields look stretched to the upside. This should lead to additional downside in the US 2-year yield, which will also feed into lower UK short-end yields.

Lower UK Yields Will Weigh on GBP

If UK yields fall further as we expect, we think GBP will also trade lower. In the coming weeks, we see GBP/USD at a new YTD low below 1.2350, a new YTD high for EUR/GBP near 0.8700, and GBP/JPY below 190 (Charts 3-5).

Chart 3: GBP/USD Spot Price = Orange Line; Chart 4: EUR/GBP Spot Price = Orange Line

Chart 4: GBP/JPY Spot Price = Orange Line

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Richard Jones writes about FX and rates markets for Macro Hive. He has traded and invested in interest rate and FX market portfolios spanning three decades, both on the buy-side and sell-side.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)