The BOE and Sterling

The Bank of England's Monetary Policy Committee concludes its two-day meeting tomorrow.  The recent data have been stronger than expected and this has boosted economists' conviction that the MPC refrain from cutting rates or resuming its gilt purchases.   

After a poor Q4 12, the UK economy has shown greater resilience this year.  The economy expanded 0.3% in Q1, which while nothing to write home about, is better than the contraction some feared or even the 0.1% expansion the consensus forecast.  The favorable news carried into the start of Q2, with April's manufacturing PMI reaching a 3-month high and the service sector PMI rising to its best level since last August.  

With these kind of numbers, while price pressures remain sticky,  BOE Governor King is unlikely to have won over converts his minority faction (which includes Miles and Fisher as well).  In fact, there is some risk that that faction experiences a defection or two.

Carney's ascension to the head of the BOE in July is awaited.  This coupled with the firmer data reinforces the idea that whatever window to resume gilt purchases may have existed now seems closed.  Even before assuming his responsibilities, Carney has been charged to report to the Chancellor in August about his stock idea of "forward guidance".  

The BOE's communication has been clear enough to convince the market that rates will not be raised before 2016 that is it not obvious what Carney's "forward guidance" can deliver.  In addition, there have been some criticism of King's management style, but there does not appear to be another major central bank in which the governor has been outvoted the way King has allowed. 

NISER expects the UK economy to expand by 0.9% this year compared with a 0.4% contraction in the euro area.  It expects the UK economy to grow 1.5% in 2014, while it forecast a 0.9% expansion in the euro zone.  Taken together, it means that in 2012-14 period the UK economy would grow by about 2.8%, while the euro area economy would be flat.  

Growth differentials may be cited to help explain the UK disappointing trade performance.  However, form a larger perspective, it appears the UK is experiencing a gradual shift in its export markets.  A decade ago, the EU absorbed almost 2/3 of the UK's exports.  Last year it was down to 50%. 

 In 2012, the UK's top five export markets  were the same as the previous three years:  the US, German, Netherlands, France and Ireland.   However, the shift is evident further down on the list.  China has moved from 9th to 7th place.  Russia has moved from 22 to 12th place.  The BRICs, which absorbed about 2% of the UK's exports in 2002 took in almost 8%, less year, surpassing Ireland's 5.8% share. 

The FTSE 100 is up about 11.6% year-to-date, making it one of the best performing major markets, behind the Nikkei's 37.4% gain and the S&P 500's 14.2% rise.    The DAX and CAC 40 are up 8.3-8.5%. UK 10-year gilts have been largely sidelined this year.  The 6 bp decline in the yield is about the same decline that German bunds have shown.  In the quest for yield, which seems to be a powerful force across asset markets, the gilts have been mostly shunned.   

Sterling has had two main moves this year.  The first was a down draft that took it from almost $1.64 at the start of the year to almost $1.4830 by mid-March--a 9.5% decline.  Since then sterling has recovered to test the $1.56 area, a 50% retracement.  On balance, we suspect it can rise toward $1.58.  A move below $1.54 would undermine this constructive outlook.  On a trade-weighted basis, sterling has recouped nearly 3/4 of its earlier loss.