The market heard a dovish Bank of England today and sent sterling down by around than one percent. Initially sterling had reached its highest level since the US election; extending its recent rally a little through $1.27, but has now reversed lower. A close below yesterday’s low ($1.2540) would be a potential key reversal. We had identified several technical signals that had suggested potential toward $1.28. Trend line and technical support are found between $1.2490 and $1.2525. A break could signal a move toward $1.2400-$1.2430 initially, and maybe $1.2260, if/when the US dollar rally resumes.
It is difficult to identify the dovish impulse. It is possible the many participants had expected a more hawkish message, Yet it revised up growth, warned that inflation would likely overshoot its 2% target on a two -year outlook. It completed its Gilt purchases but have a few billion more of corporate bonds to buy to reach its GBP10 bln target, but is running well ahead of schedule.
The growth forecast for this year was lifted substantially: from 1.4% to 2%. Growth is expected to slow to 1.6% in 2018 and 1.7% in 2019. Inflation is expected to be 2.6% in two -year and peak near 2.8% in H1 18. The dovish tint to the growth forecast that has implications for inflation expectations comes from the BOE discovering spare capacity in the UK economy.
The slack is in the labor market. Unemployment, the Bank of England now says, can fall to 4.5%. Previously 5% was thought to be full employment. For policymakers, this means that the economy growth may not be inflationary. In turn, that means that the projected increase in inflation may not be so worrisome and more transitory, having to do with sterling’s past slide and the recovery in oil prices. Later this year, large parts of the fall in sterling and the increase in oil prices will drop out of the comparisons (base effect).
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