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Pound traders piling into bets on an interest-rate cut this month are getting a warning from strategists preaching the virtue of patience.
Bank of New York Mellon and Nomura International are calling for calm after the market became the most aggressive on an imminent rate cut from the Bank of England since 2016, pricing in a more than 60% chance. They recommend waiting for more evidence of the economic implications of Prime Minister Boris Johnson’s decisive election win, with next week’s Purchasing Managers Indexes particularly in the spotlight.
“The market is perhaps being overly hasty in adorning its dovish hat,” Neil Mellor, a senior currency strategist at Bank of New York Mellon, said in a note to clients. “It could be that the market has yet to embrace the very clear possibility that the MPC will postpone any decision on rates until it can be sure about the health of underlying demand.”
The pound has been hammered this month after a flurry of dovish statements from BOE policy makers seemed to put a January move in play. The volume of trading in short sterling options jumped to the highest in almost three months on Wednesday. Bond traders, too, look to be adjusting to a potentially imminent cut, with the yield on 10-year gilts falling almost 20 basis points in 2020, the best start to a year since 2016.
But a number of surveys suggest optimism has picked up since the vote, with the BOE’s own tracker of uncertainty showing a drop in Brexit concerns. A report Thursday showed that the housing market perked up in December, with sales and price expectations both improving.
“This is the basis for talk of a ‘Boris bounce’ and surely prudence warrants one month’s patience in gauging its likely vitality,” Mellor said.
Incidentally, three-week sterling-dollar risk reversals, a measure of sentiment that covers the BOE’s Jan. 30 meeting, shows demand for calls and puts is almost matched. That means traders are on the fence on where the currency will go after the rate decision.
More Than Words
The increased likelihood of a January cut has been fueled by BOE officials since the turn of the year. In his first major speech of 2020, outgoing Governor Mark Carney said the MPC has plenty of firepower to aid the economy if necessary.
On Wednesday Michael Saunders, who’s been leading the charge for a cut, said the economy needs an aggressive injection of stimulus. Expectations for easing have pushed sterling down about 1.5% this year.
“What surprises me is that the BOE can see the effect the comments are rightly or wrongly having on expectations and the pound, but no one appears to be pushing back against them,” said Stuart Bennett, head of G-10 currencies strategy at Banco Santander SA.
Most of the economic data released so far this year have covered the period before the election, so strategists are looking elsewhere for clues.
For example, a poll of chief financial officers by Deloitte LLP showed optimism about their companies’ financial prospects had reached a record high. Brexit, the biggest worry since the 2016 referendum, sank to third place behind concerns over weak demand and geopolitical risk.
Against that backdrop, the U.K.’s latest Purchasing Managers Indexes, due Jan. 24, are looking like make-or-break numbers before the BOE decision.
What Our Economists Say:
“The main hurdle to a rate cut remains the January PMI. If the survey rebounds, as we expect, it is likely the central bank will hold fire.”
-- Dan Hanson, Bloomberg Economics
Other key data points are December’s retail sales figures, due on Friday, and private surveys of house prices and consumer confidence.
Even an improvement in the data may not be enough to deter some BOE officials from pushing ahead with a cut. Saunders said that delaying has a price and it’s better to move quickly.
If the BOE do cut, it’s “one and done,” said Nomura International strategist Jordan Rochester. It will “probably mark the low in the pound as the U.K. and global data are witnessing clear signs of a recovery.”
(Updates with drop in gilt yields in the fourth paragraph)
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