News & analysis

Thursday’s Bank of England meeting will mark a shift in priorities for the Monetary Policy Committee. At March’s extraordinary meeting on the 19th, the main objective was to restore functioning in UK financial markets, especially gilts, and preventing further tightening in financial conditions.

With progress having been made towards these objectives the MPC’s focus is now likely to shift towards providing liquidity to UK companies and the sisyphean task of predicting the depth of the virus shock and the shape of the recovery. For now, sterling has traded most of this week in line with its G10 peers, and has rallied against the US dollar.

However, with risk appetite improving idiosyncratic factors such as monetary policy and government plans for re-opening are more likely to play a role in driving FX movements.

This week’s MPC meeting and Government re-opening plan may therefore offer sterling a chance for idiosyncratic moves based on these factors, as opposed to general trends in risk sentiment.

The last regular Bank of England meeting on the 25th of March was something of a placeholder. The Monetary Policy Committee voted unanimously to leave rates unchanged at 0.1% after lowering them to 0.1% at a special meeting on the 19th of March that also saw the announcement of £200bn in purchases of gilts and investment grade corporate bonds. In addition to this, and in conjunction with the Federal Reserve, the BoE made US dollar liquidity available in repo operations to the domestic UK financial system. The increase in asset purchases was explicitly aimed at calming functioning in UK financial markets, especially sovereign markets, which had seen liquidity break down in the days leading up to the 19th of March.

Intraday ranges spiked, while bid-ask spreads widened, in developments matching those in other sovereign markets, threatening the transmission of monetary policy as market participants scrambled for liquid, short term assets. Similar chaos developed in cross currency funding markets, with cross-currency basis swap spreads widening in volatile conditions. The Bank of England’s interventions on the 19th coincided with those of the European Central Bank, and were followed soon after by the announcement of open-ended QE and a host of credit easing measures from the Federal Reserve. Since then, conditions in money markets have eased, with gilt volatility subsiding and cross currency basis swap pricing also reflecting less pressure on US dollar funding. From this perspective, the BoE’s asset purchases and rate cut appear to have done their job. Further expansion of asset purchases is possible on Thursday’s meeting given the £200bn allotment of purchases are likely to be completed within a matter of months, but is not guaranteed and will not be the main focus of the meeting.

 

Chart: BoE intervention on 19th stabilises markets

In addition to these monetary measures, aimed at stabilizing UK money markets…

The BoE has also actively collaborated with HM Treasury in implementing or expanding a number of facilities to provide liquidity to corporates. These include the Covid-19 Corporate Financing Facility (CCFF), the Term Funding Scheme with additional incentives for SMEs, and the Contingent Term Repo facility (CTRF), aimed at meeting liquidity needs for different UK money market and corporate entities. The effectiveness of these measures will hopefully be a topic of consideration on Thursday, along with any possible expansions. The CTRF facility, a short term collateralized loan offering, is currently due to see its last weekly offering on the 29th of May, and may be extended, given MPC communication has been clear that its operation will remain “under review”. The rate of uptake of the CCFF, which has reportedly been low, may also come under consideration, although poor uptake of the facility may have been due to standards set by the Treasury.

Thursday will also see the MPC begin to grapple with the task of judging the depth of the virus shock to the economy, and judging the shape of a potential recovery. The depth of the initial shock seems by any available measure to be the worst in relevant history: OBR analysis used a 35% drop in GDP in the second quarter as its baseline, taking an optimistic view that growth would recover in Q3. The pave and timing of recovery is the more difficult of the two – the MPC is not required to give an exhaustive description of member’s views, but any color provided in the meeting minutes will be interesting. In particular, if MPC members are skeptical of the pace of recovery in Q3, a stronger case can be made for expanding asset purchases, strengthening forward guidance, or expanding credit easing and liquidity measures.

 

Chart: GBPUSD

 

April labour market reports in focus for USD and CAD next week

Last week’s North American data calendar was centered on the US, with the FOMC and first reading of Q1 GDP being the standout events. However, both events proved to have limited market impact. On Wednesday eve, the FOMC refrained from painting themselves into a corner by giving explicit forward guidance, or even changing the IOER rate to protect the lower bound, while the advanced Q1 GDP reading came in close to expectations with an annualized contraction of 4.8%. The dollar mainly brushed over this news and was instead hit by month-end flows. Elsewhere, the weekly release of US unemployment insurance claims data fell to 3.839m in the week ending April 25th, its slowest increase in April. For the Canadian dollar, the $1.40 level was the significant test for the week. After rallying below this psychological threshold on the back of broad US dollar weakness towards the back-end of the month, the loonie failed to hold on and soon found itself trading back in the $1.40’s.

The week ahead for both the dollar and loonie focuses on the highly anticipated April labour market reports set to be released at 13:30 BST on Friday. While higher frequency data releases such as unemployment claims data has been the main focus for markets to measure the true damage inflicted on the North American economies, the official unemployment measure is likely to give a truer reading.

We have previously looked at the quirks in such data releases since the impact of Covid-19, with a lot of attention given to claims data due to its newly founded market impact.

Under the current system, unemployment claims includes those temporarily displaced from working, meaning it may overstate the true structural unemployment rate once lockdown measures are eased. These workers, while filing for unemployment benefits, especially those under the CARES act, may not necessarily consider themselves “unemployed” under the survey measures. Additionally, the timely data doesn’t incorporate the number of workers who have left the labour market altogether, in turn reducing potential output on a longer-term basis. There are also those who have ceased working but are yet to file their unemployment claim, opt not to, or are yet to be processed. In this light, with extra information to be added to the market information set with the latest official data, Friday’s release is likely to induce market volatility despite the recent focus on claims data.

This is best represented by the array of economist estimates for both the US and Canadian unemployment rates. In the US, the median forecast by 24 economists suggests the unemployment rate is expected to come in around 16%, while the claims data suggests over 30m unemployed since the start of March, equating to an insured unemployment rate of 12.4%. In Canada, the median expectation for April unemployment is currently for a rise from 7.8% in March to 20% in April, although the number of submissions remains limited a week out.

 

Chart: New jobless claims rise above 30m mark since beginning of March, but pace of growth continues to abate

 

Authors: 
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Ima Sammani, Junior FX Market Analyst

 

 

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