No Regular Hump Day for the UK Tomorrow

Sterling peaked last Tuesday just below $1.70. It has since recorded lower highs in each of the five sessions since. This seems to reflect some profit-taking by weak longs. Others appeared to converted the long cable position into a short euro/long sterling cross position. The euro has slipped today to its lowest level against sterling since early last year.

Tomorrow is an important day for the UK. Unlike most central banks, when the Bank of England does not do anything, it does not talk about it. However, now that forward guidance is a more important tool by which the central bank tries to shape expectations, the Quarterly Inflation Report takes on greater significance.

An hour before the BOE's Quarterly Inflation Report, the UK will report the April employment figures. Another 30k decline in the claimant count is expected. The unemployment is expected to slip to 6.8% from 6.9%. Average weekly earnings (reported with extra month lag) likely rose more than CPI (March 1.6%), pointing to real wage increases.

This has a direct bearing on the BOE's forward guidance. Specifically, the BOE argued early this year that growth was likely to slow and that the spare capacity in the economy, which was concentrated in the labor market would not be absorbed for 2-3 years.

Tomorrow's Quarterly Inflation Report will be considerably more upbeat. Not only has growth held up, if not accelerated, the headwinds from the euro area have diminished. The increase in real earnings is a preliminary signal that the there may be less economic slack than the BOE thought a few months ago. Carney, for example, had suggested that the output gap may be larger than the upper end of the BOE's estimated range of 1.5%. 

This quarter the UK economy is likely to surpass its pre-crisis peak. Whatever output gap was thought to exist in February, the estimate is likely less now. The QIR may be sterling positive and gilt negative.

BOE Governor Carney is likely to highlight the role of macro-prudential measures to address the potential risks to financial stability emanating from the housing market. The Financial Policy Committee meets next month (June 17), and there is much talk about measures, including tightening underwriting standards, and loan-to-income ratios. However, this may be a bit too soon for action.

Macro-prudential measures, which are expected to be announced in the coming months, do not simply complement the forward guidance, but we suspect, will be presented as an integral part. Specifically, using macro prudential measures to address the housing market may lend credibility to Carney's desire to hold off a rate hike for longer.