GBP: 8-1 inflicts minor setback, BoE raises rate profile

Sterling 5y and 10y swap rates rose around 2bp but Sonia forward rates are dribbling lower after it emerged that the BoE MPC voted 8-1 to keep the Bank rate unchanged at 0.50%. The Bank did not rule out the possibility of a return to negative inflation figures in the short-term. The MPC was unanimous in its vote to keep the stock of asset purchases unchanged at £375bn. The Bank also said it would begin to reinvest the £16.9bn of maturing gilts in the week starting 7 September, spread evenly across the different maturity horizons (3- 7 years, 7-15 years and over 15years).

The pound retreated against its major G10 and EM counterparts but the correction is likely to be shallow and may not last long given BoE governor Carney said that the previous strength of sterling has not removed the need for a gradual rate increase. A first rate increase is unlikely to be held back by low inflation in the short -term. Governor Carney made clear however that the MPC is not pre-committed to any future rise in rates, which came across less hawkish than his remarks three weeks ago in front of the Treasury Select Committee. Much will depend on the pace of wage growth and the evolution of the output gap, i.e. the difference between actual and potential output growth. The gap is forecast by the BoE to close 'over the next year or so'.

The minutes of the meeting (the MPC voted yesterday) were released simultaneously with the rate decision and revealed that McCafferty was the lone hawk preferring an immediate 25bp rate increase based on his view that risks to the medium-term inflation outlook were sufficiently to the upside. His dissent is the first since last December but it falls short of the two or more members on the MPC that had been anticipated to vote for higher rates today (Weale voted with McCafferty for higher rates last year). This was another small tactical setback for GBP longs but is unlikely to change the still bullish medium-term outlook, says Societe Generale.

The BoE inflation report, also published today, revised up the path of future interest rates to 1.75% by the second half of 2018, 30bp higher than in the May forecast. The inflation forecast for 2015 was lowered from 0.6% to 0.3%, but is seen accelerating to 1.6% next year before reaching the 2% target in two years. The forecast of wage growth this year was revised up from 2.5% to 3%, but is seen averaging 3.75% next year as a function of the closing of the output gap.

The BoE made no changes to its 0.5% estimate of the output gap compared to May. This suggests that it wants to see further evidence of the labour market tightening and wages growing at a faster clip before it pulls the trigger on interest rates. The GDP forecast for 2015 was raised from 2.5% to 2.8%.

"GBP/USD briefly dropped to a 1.5468 low before rebounding over 1.5500. Only a break of 1.5409 would threaten to set off a deeper pullback towards 1.5250. The next move will now depend on the US NFP data tomorrow. For EUR/GBP, a break of 0.7045 is required to open up a return to the 0.7100/28 area. Against emerging market currencies, GBP/RUB fell back to below 100 after trading an intra-day high of 100.573 but the pullback should be short-lived", notes Societe Generale.