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Bank of England Next move on hold

Written by A Forex View From Afar on Friday, August 22, 2008

The pound fell close to 1500 pips in the past two weeks, practically shedding every gain the pair made in the last two years, due to the market’s view that the Bank of England will cut at the following rate meetings. But, would they really do this? The meeting minutes released today do not suggest this, nor does it leave too many interpretations that the bank will abandon its target inflation regime to assure growth. The mandate that the MPC follows is price stability, and that is reflected in the stubborn way that the U.K. has held onto rates above 5.0%.

The vote was split, 7 members voted for a hold, while 1 member, Mr. Tim Besley, voted for an increase. On Tuesday the market sold the pound lower, directly after voting Monetary Policy Member Tim Besley stated that inflation in the U.K. would fall by year-end, and as such signaled that the Bank of England would possibly have no barriers to a series of rate cuts to help the beleaguered home and business owners who are suffering with 5% overnight interest rates. U.K. bond prices rose on this news, and that also added to bond values moving higher in reaction to negative equity markets, pushing down yields and automatically reducing the value of the pound. The vote from Mr. Besley was different from the opinion two weeks prior.

There was 1 vote from Mr. David Blanchflower, the MPC perma-bear, who suggested that monetary policy should be loosened. The August meeting represented the second meeting in a row, when the vote was divided this way 7-1-1. Overall, the meeting shows inflation still remains the major concern for the bank. Even if risks to the housing and economic outlook increased since last month, a rate cut is out of the way for the bank it seems. Risk to inflation poses a bigger long-term threat for the bank than an economic slowdown.

Inflation is now running at 3.8%, almost twice as much as the central bank’s target, with large increases in the food and energy sub-indexes. At the same time, according to the inflation report released earlier and not the hot air blowing of MPC members, the CPI read is expected to remain significantly above the target this year and stay above it at the start of 2009. Inflation is only expected to reach the MPC 2% target by 2010. The Inflation report that shows the central bank does not exclude the possibility of a negative quarter in the following period, however GDP growth is expected to pick up in 2009.

If the UK economic situation does not deteriorate much further in the following weeks, we may not see a rate cut from the Bank of England. There is only one member voting for a cut right now and will need at least another 4 members to reverse their thinking to obtain the majority; the voting trend does not support that, even in the face of a severe slow-down in the economic outlook. If the voting trend stays the same, then the pound’s downward movement may lose steam as the market sees a bank that is willing to stand behind their inflation objective; lowering rates into raging inflation is a sure-fire way of mortgaging forward growth, and sets up very shallow boom to bust cycles.

If rates are cut, inflation increases and the value of future growth is stripped. A short-term fix to cut rates can cost a lot more in the long run than the initial cost to the consumer in taming inflation. There is no dual mandate at the BoE it seems, and the market may soon look at the rate cut valuations that are in the pound right now as being a little imbalanced, unless, that is, the next few weeks before the MPC meeting offers deteriorating economics.

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There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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