GBP/USD May Pull Back Towards 2.0450 on Dovish BOE Meeting Minutes

How Will The Markets React?  The biggest event risk for the UK markets this week comes from the release of the minutes from the Bank of England’s November meeting, as they are likely to echo much of the sentiment reflected in the Quarterly Inflation Report. However, the market-moving piece of information will be the vote count, as just a few additional motions for a rate cut could lead investors to ramp up speculation that the BOE will indeed make monetary policy more accommodative in coming months.Despite a surprise surge in inflation above the bank’s 2.0 percent target early last week to 2.1 percent, the Quarterly Inflation Report proved to be surprisingly dovish. While the BOE’s view that inflation risks are 'balanced' and expectations that GDP growth will slow 'sharply' in 2008 sound decidedly neutral, the bank’s outlooks assumed at least one rate cut in 2008, providing a markedly dovish tone. This was somewhat contradictory to the market's perceived bias beforehand. With oil and other commodity prices rocketing to record highs, there are well-warranted concerns that global inflation will rise significantly, and the prospect of increased price pressures only compounds the problems that the BOE already faces as they contend with uncertainty surrounding the ongoing reappraisal of risk in the financial markets. Indeed, it appears that Bank of England Governor Mervyn King has started to fold under pressure after taking quite a bit of flak following the run on Northern Rock in September, as critics say that he failed to help the situation when he refused to provide extra liquidity amidst the rapid tightening of the credit markets. In fact, King – an ardent inflation hawk that is strongly against increasing the risk of moral hazard – left the UK's benchmark lending ready steady at 5.75 percent for the fourth consecutive month on November 8th, as more accommodative monetary policy would only fan price pressures. However, it is starting to become clear that the bank will probably cut rates by 25bp to 5.50 percent in the first quarter of 2008, which will do little to reignite a bid for the British pound or quell gains for Gilts. Bonds – Long Gilt Futures

Gilts pushed up the highs and resistance at the 109.94 level, as bulls remain in control and could ultimately extend towards 110.70, especially if equity markets remain weak and on upcoming UK event risk. On Wednesday, the release of the BOE minutes could lead the markets to ramp up speculation that the central bank will cut rates in coming months, especially if the November vote shows a surprising vote. Expectations are for a 6-3 vote, which could be enough to support Gilt gains, but a 5-4 vote would surely send the contract rocketing higher. On the other hand, an unexpectedly neutral report could weigh Gilts down.

FX – GBP/USD The British pound continues to rally after bouncing from trendline support at 2.0350, as dollar weakness remains one of the major drivers of the forex markets. However, one of the reasons GBP/USD dropped last week was the surprisingly dovish Quarterly Inflation Report from the BOE, and this sentiment could emerge again on Wednesday. Indeed, the minutes from the BOE’s November monetary policy meeting are scheduled to be released, and they are anticipated to reflect a 6-3 vote to keep rates steady, with the remainder in favor of a 25bp cut. After the October meeting showed an 8-1 vote, the news would suggest that the MPC board is becoming increasingly likely to cut rates during the first quarter of 2008. Furthermore, the discussion during the meeting is likely to highlight additional concerns regarding growth and the instability in the financial markets, all of which may be bearish for Cable. Support lies below at 2.0450 and the aforementioned trendline at 2.0350, providing much room for the pair to fall. Nevertheless, if dollar weakness remains the name of the game for the forex markets, GBP/USD could continue to ascend towards 2.10. Is GBP/USD destined to break below 2.00 or continue its rally? Discuss the topic in the

Equities – FTSE 100 Index  On Monday, the FTSE 100 fell through critical support at 6,175 and as of Tuesday, appears to be attempting a comeback. However, with global equities looking weak in general, the resulting gains could be mild with resistance above at the confluence of the 100 SMA and 200 SMA at 6,415/27. On Wednesday, the release of the minutes from the November BOE meeting may not have as much of an impact on UK equity markets as it will on FX and fixed income markets. Nevertheless, traders should watch the report as gloomy growth outlooks could hurt the FTSE 100 and push the index towards the August lows of 5,822. On the other hand, signs that the BOE will cut rates within the next few months could provide some relief to investors worried about the instability in the financial markets. 

Written by Terri Belkas, Currency Analyst for DailyFX.com