From the FXWW Chatroom: Mansion House speeches have been market movers in the past, with short end UK rates moving up to four times their average the day after (figure 1). As noted in our preview yesterday, we think Governor Carney could sound a more dovish note tomorrow, partly reflecting relatively mixed data since May and partly as an acknowledgement of rising global trade risks and a more dovish ECB. But we haven’t given up on our bullish sterling view.
First, we doubt Carney abandons the BoE’s hawkish bias, and will stick to guidance that tightening will be required over the coming year. With the market pricing only around a 30% probability of a hike in August, and the MPC highly data dependent, it would only take UK economic surprises to bounce from their lows for August to become a realistic prospect again. There are also risks that CPI starts to climb again in June as a result of commodity price rises and retailers implementing price hikes.
Second, the best guide to sterling versus other currencies over the last couple of years has been relative terminal rates pricing (figure 2). UK real rates remain excessively rich relative to peers, reflecting market concerns about a hard Brexit outcome. On that front, our view of a pivot from the UK government towards soft Brexit in the coming months hasn’t changed. Votes in the last two weeks in the House of Commons have underscored the lack of parliamentary support for no deal. At the same time, next week’s European Council looks less like a banana skin following leaked guidelines Tuesday, with the EU27 more focused on trade and immigration concerns.
Timing is more challenging, with a risk that Brexit compromises are postponed until after the Conservative Party conference in October. But with positioning close to flat, and a summer Bank of England hike still in play, we’d stick to sterling longs for now.
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