Sterling hovered near two year lows last week, as Boris Johnson was installed as PM and confirmed that his strategy was to insist the EU reopen the Withdrawal Agreement. The EU duly refused.
Notably, the confirmation of Boris and “do or die” by the 31st did not weaken sterling further. This suggests that a very substantial amount of uncertainty is already in the price for sterling.
However, OIS pricing suggests that a no-deal Brexit is still not the market’s base case, with a rate cut priced at 40% probability compared to a 6% probability in September.
Any dip-buyers tempted by the lack of downside on last week’s move towards Boris, must therefore be willing to confront further severe downside.
The BOE will assess worsened risks and dismal survey data…
Depending on who you ask, this week the Bank of England will either give a sobering assessment of the worsening costs and risks of Brexit uncertainty, or indulge in another bout of “project fear” doom mongering about the risks of a no-deal Brexit.
May’s Inflation Report was fairly optimistic, expecting a decent return to growth in the second half of the year, with GDP growth reaching 1.5% for the year and 1.6% in 2020.
The risks now seem tilted solidly to the downside of these expectations after a series of poor survey released since May, including a crash in investment intentions and the worst run of PMIs since 2016.
Looking purely at PMIs, the economy is likely to have contracted in the second quarter.
…But don’t expect the MPC to follow Fed insurance cuts
Despite the grim tone of UK survey data, the Bank of England is unlikely to follow the Fed and enact “insurance” rate cuts this week. Due to the still-robust state of the labour market and sustained consumer spending, the BoE is highly unlikely to cut based on this one quarter of poor activity.
Relatively optimistic data from the retail sector and labour market supports the conclusion that households remain unfazed by Brexit and are happy to spend real wage increases.
June’s retail sales report was broadly typical of the past year, with total sales rising 3.6% year-on-year.
Mortgage Approvals remain steady above their 12 month average – another data point that suggests household behaviour was unaffected by the Q2 fall in business confidence.
The latest UK labour market data, from May, shows that the Q2 slowdown did not affect wage growth, which reached a rate of 3.6%, the highest since 2008.
A further, severe shock could certainly change the relatively sunny state of wage growth and consumer spending. But based on the current state of both indicators this has not yet begun to happen. As a result, the BoE has good reason to stay put until after October.
One interesting aspect of this week’s Inflation Report is that in the past, the BoE has assumed a disruptive Brexit will be avoided, partly because this was official Government policy.
With the Government now officially embracing no-deal, a more serious consideration of the consequences may begin to enter into the MPC’s thinking.