Sterling firms as MPC Splits

Surprises becoming unsurprising

The MPC meeting yesterday was expected to show concern over inflation, accept that the fall in Sterling was the main culprit and move on. A 7-1 vote in favour of the status quo with Kristen Forbes the lone dissenting voice was the stock view.

In the event, a 5-3 vote in favour of unchanged rates surprised the market and drove Sterling higher. Kristen Forbes was joined in voting for a hike by Ian McCafferty and Michael Saunders. McCafferty has been a member since 2012 while Saunders joined last year. Neither are known as particularly hawkish and a conspiracy theorist would draw the conclusion that the MPC needed to show greater concern over inflation without any material change to its policy stance. So, these two were chosen to be the “rate hike standard bearers”.

Sterling initially rose to a high of 1.2796 before settling back into the mid 1.2700’s. Against the Euro it continues to defy the 0.8800 level climbing to 0.8722.

Interest rate futures which predict the future path of rates, now show a 30% chance of a rate hike this year. Given concerns over political instability, economic growth and Brexit, a rate hike could actually be damaging in the medium term.

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Central Banks remain in focus

Following the rate hike in the U.S. and yesterday’s MPC meeting, Central Banks are starting to be questioned as to their credibility as the global economy emerges from the worst global downturn in almost a century.

The reason for the rate hike in the U.S. is being questioned given the proximity of this move to the two previous ones. Does the economy really need the brakes to be applied just yet? Employment, growth and inflation are seemingly indicating a period of reflection rather than action.

Contrast this with the U.K. Inflation is seemingly out of control, the pound is faltering, despite a rise yesterday, and Brexit is providing strong headwinds. Yet, we are now significantly closer to a hike than at any time since rates were cut in August last year.

The Governing Council of the European Central Bank is presiding over a growing sense of growth and stability in the Eurozone and President, Mario Draghi has said a rate hike could be some way away. With inflation benign across the whole region the task of the ECB would appear to be the simplest.

EU leaders will be tough over Brexit

The U.K. was never in for a smooth ride whenever formal negotiations start. Despite a clear sense that there was never a full commitment on the British side, the EU was happy to have a significant partner.

The Brexit vote would have been far clearer had the Government considered adopting the Euro. British society is committed to the pound despite what could have been seen as significant commercial and business advantages of “joining the nineteen”.

Following last week’s election shock, Britain is now going to have to agree to accept the full financial burden of departure if it is going to be allowed access to the single market for goods and services. Immigration, a major part of the “leavers” platform, will also be a focus as a deal for EU nationals living in the U.K. will need to be agreed. It is likely that talks will begin in Brussels next week although given what we have seen over the past week nothing is ruled out.

Emmanuel Macron, the new French President, showed in pro-Eu colours earlier this week by commenting that the door remains open should the U.K. change its mind. Stranger things have happened!