Yesterday, the Bank of England left its interest rate at 0.50% and increased its program of quantitative easing by £25 billion to a total of £200 billion. The British pound immediately rallied on the news against all major currencies – apparently, analysts already expected the increase and were afraid the BoE might actually increase quantitative easing (QE) by £50 billion. The reaction is another example of how expectations can matter more than the news. For example, in the rate decision last month, the BoE left the QE program unchanged and the pound staged a tremendous one-day rally that capped a week-long move. (Note well that the pound is now around the same price as it was then).
To me, the big news is that the BoE’s move confirms that the British economy is suffering on-going and stubborn weakness. Indeed, the BoE projects “on balance, the Committee believes that the prospect is for a slow recovery in the level of economic activity, so that a substantial margin of under-utilised resources persists.”
The BoE also provided a subtle hint that it wants to maintain the depreciation of its currency: “The sterling effective exchange rate lies around a quarter below its mid-2007 level, improving the competitiveness of UK producers.” This statement is a matter of fact, but the BoE chose to measure the currency’s value from a time when the pound was extremely strong against the U.S. dollar and the yen, peaking after a strong seven-year run. It was worth two U.S. dollars and 250 yen. While the trend since then points downward, the shorter-term trend has featured strength in the currency. By choosing the longer-term trend, the BoE confirms it does not want the pound to appreciate further.
If the BoE had measured the currency’s value since the depth of the recession from January-March, the statement would have to note that UK producers are becoming less competitive as the recovery drags along. This statement is much more negative (is the glass half empty or half full?). Regardless, the BoE once again extolled the benefits of a weaker currency.
The pound is now up about 20% against the U.S. dollar from the depth of the recession in March, and it is now sitting right under the upper resistance level around 1.66/1.67. The recovery peak was set in early August at 1.70. Since part of the point of increasing QE is to devalue the currency, I strongly suspect that a break in these levels will get officials talking more directly about the need to keep the value of the pound from appreciating further.
Be careful out there!
Full disclosure: no positions
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