Dovish BoE
The pound came under pressure after the BoE’s Quarterly Inflation Report surprised the markets with a weak inflation projection. The BoE sees UK CPI near 1.6% in 2 years time, down from 1.8%. Cable dropped to 1.5900 and EURGBP came close to touching 0.80 as wider risk aversion kept the dollar in demand and the BoE surprised markets. Their GDP growth forecast was also slightly lower. Inflation is revised up in the short term, as expected, but it appears to have been revised lower for the critical 2-3 year horizon. The decision to lower the longer term inflation forecast seems hard to reconcile with the bank’s decision to halt its QE program in May and Mervyn King seemingly dodged questions on this subject in the press conference. Earlier, employment data was stronger then expected with jobless claims falling by 13.7k in April, leaving the claimant count unchanged at 4.9%. Elsewhere, markets remained in clear risk averse territory with the dollar better bid across the board. The fact that Mervyn King dedicated a large portion of his press conference to express his concerns over the developments in the Eurozone highlights where investor focus is. Sentiment took a turn for the worse overnight when the Wall Street Journal reported that depositors withdrew EUR 0.7 bn from Greek banks on Monday alone. USDJPY would normally be expected to weaken in such an environment, but it was held aloft by unsubstantiated market conjecture that the BoJ may lower the interest it pays on cash balances held at the central bank. Interest is currently paid at 10bp which acts as a floor on JGB yields. If this rate were lowered, front end JGB yields in particular would have room to fall further making future easing more effective. Indeed 2y JGB yields fell below 10 bp overnight for the first time since 2005 suggesting the market may be starting to position for this outcome. Also, the BoJ received insufficient bids when buying JGBs for its Asset Purchase Program overnight, suggesting some market participants would rather keep their front-end JGBs at least until next week’s BoJ policy meeting in case a rate adjustment emerges. Meanwhile in Greece talks to form a new government have been abandoned and an election date (likely June 17) may be announced today when party leaders convene again at 10:00 GMT. Given the continued political uncertainty plus the associated fears of a halt or postponement of external support, a hard default and fears of a euro exit, our negative euro view remains intact. We would expect the negative pressure on the euro to intensify as we get closer to the ‘funding wall’ in Greece, when the financing dries up – widely foreseen around mid-to-late June, coinciding with the impending election. FOMC minutes are due – the last edition of which proved to be USD supportive.
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UBS Investment Bank