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The OECD is right; the Bank of England can leave rates on hold. Sterling tests June lows
Neil Wilson
Investor Content Strategist
Note: This is marketing material. This article is not investment advice, capital is at risk.
The OECD is absolutely right – the Bank of England can (and I would add ought to) avoid raising interest rates because it's starting from a very different position to other countries. This chimes exactly with the argument I have been making for several months since the onset of the war in the Middle East; that the market is mispriced way too hawkish.
According to the OECD, the BoE can afford to leave its benchmark steady at 3.75% until well into 2027, after which the next move is to cut. Markets are on the other hand pricing in four hikes through to the end of next year. Britain's policy rate is already quite restrictive at 3.75% and there is yet no clear evidence of second round impacts on inflation - the OECD cut its inflation forecast to 3.1% from 3.7% predicted in June and predicted further deceleration to 2.6% in 2027.
The view from the OECD – which also upgraded its growth outlook for the UK for the year – came as the latest purchasing managers' index pointed to sluggish growth in September and weak momentum heading into the fourth quarter. The pace of expansion in the private sector slowed to a 3-month low and we might expect a further slowdown as almost inevitable into the year-end, at least until Budget-related uncertainty fades and we see a similar effect to last year with the fiscal setpiece acting as a kind of clearing event for businesses. And while the inflationary pressures are rising, with input inflation accelerating for a second month, I would argue the downside risks to the economy outweigh upside risks to inflation. To repeat a well-worn phrase, this is not 2022; there are lots of good reasons to stay on the sidelines.
The OECD view ought to be listened to by those on the Bank's rate-setting Monetary Policy Committee who may be tempted to vote for a 25bps hike in November. Of the 6 committee members who voted to hold rates steady this month, there were 4, including the governor Andrew Bailey, who sounded in their prepared remarks like they may be tempted to hike in November, if energy prices remain elevated.
Sterling is weakening further – whether the OECD's view matters to Mr Market or not, we have oil down for a sixth session, supportive of the more dovish position. With US rate hike bets firming up for October now we can see clear reasons why sterling should be weaker. GBPUSD broke down at 1.3360 support then below 1.330 to under 1.3280 with bears looking to take out July's pre-FOMC lows around 1.3270. Ultimately, my view is that sterling should be lower and should retest 1.314, the June cycle low.
Whilst some of this is a dollar-bid move, EURGBP has also strengthened though yet to break out a new cycle high as yet, though with Eurozone PMIs looking solid we should see some more hawkish repricing for the ECB. Europe is proving more resilient than expected: Eurozone private sector growth accelerated to its fastest in three and a half year, boosted by AI and defence spending. The flash reading from S&P Global showed output grew at the fastest pace since April 2023. Manufacturing, led by Germany, is enjoying its best pick-up in four years. Alongside this improvement in activity input and output cost inflation pressures were sharp and the highest since May. Enough for the ECB to sit up and take note, though as John Hardy notes today the blowout in Franco-German spreads is a negative development for the euro.
According to the OECD, the BoE can afford to leave its benchmark steady at 3.75% until well into 2027, after which the next move is to cut. Markets are on the other hand pricing in four hikes through to the end of next year. Britain's policy rate is already quite restrictive at 3.75% and there is yet no clear evidence of second round impacts on inflation - the OECD cut its inflation forecast to 3.1% from 3.7% predicted in June and predicted further deceleration to 2.6% in 2027.
The view from the OECD – which also upgraded its growth outlook for the UK for the year – came as the latest purchasing managers' index pointed to sluggish growth in September and weak momentum heading into the fourth quarter. The pace of expansion in the private sector slowed to a 3-month low and we might expect a further slowdown as almost inevitable into the year-end, at least until Budget-related uncertainty fades and we see a similar effect to last year with the fiscal setpiece acting as a kind of clearing event for businesses. And while the inflationary pressures are rising, with input inflation accelerating for a second month, I would argue the downside risks to the economy outweigh upside risks to inflation. To repeat a well-worn phrase, this is not 2022; there are lots of good reasons to stay on the sidelines.
The OECD view ought to be listened to by those on the Bank's rate-setting Monetary Policy Committee who may be tempted to vote for a 25bps hike in November. Of the 6 committee members who voted to hold rates steady this month, there were 4, including the governor Andrew Bailey, who sounded in their prepared remarks like they may be tempted to hike in November, if energy prices remain elevated.
Sterling is weakening further – whether the OECD's view matters to Mr Market or not, we have oil down for a sixth session, supportive of the more dovish position. With US rate hike bets firming up for October now we can see clear reasons why sterling should be weaker. GBPUSD broke down at 1.3360 support then below 1.330 to under 1.3280 with bears looking to take out July's pre-FOMC lows around 1.3270. Ultimately, my view is that sterling should be lower and should retest 1.314, the June cycle low.
Whilst some of this is a dollar-bid move, EURGBP has also strengthened though yet to break out a new cycle high as yet, though with Eurozone PMIs looking solid we should see some more hawkish repricing for the ECB. Europe is proving more resilient than expected: Eurozone private sector growth accelerated to its fastest in three and a half year, boosted by AI and defence spending. The flash reading from S&P Global showed output grew at the fastest pace since April 2023. Manufacturing, led by Germany, is enjoying its best pick-up in four years. Alongside this improvement in activity input and output cost inflation pressures were sharp and the highest since May. Enough for the ECB to sit up and take note, though as John Hardy notes today the blowout in Franco-German spreads is a negative development for the euro.
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