BOE in focus after the Fed

Market prepares for the BOE

The US may have experienced whipsaw price action on the back of yesterday’s Fed rate cut, but there has been a straightforward welcome to the Fed’s dovish leap into its rate cutting cycle in Asia and Europe. The Nikkei is higher by 2.5% and the Hang Seng is higher by more than 1.8%. European futures markets are also pointing to a higher open later this morning, the FTSE 100 is expected to open up 0.7%. US futures are also higher on Thursday morning. The gold price initially rallied to a fresh record high on the back of the 50bp rate cut from the Fed, before faltering at this level, however the price of gold is rising once more as we move towards the open of the European session.

A new era for central banking

Yesterday’s meeting hailed a new era for central banking. The Fed slashed their interest rate forecasts even though their forecasts for core PCE inflation are not set to fall back to the Fed’s own target rate until 2026. The Fed have ditched waiting for inflation to fall back to target before aggressively starting their rate-cutting campaign. This would not have happened in past decades, and it suggests that the Fed is less guided by its inflation target than it once was, and instead avoiding a recession is its chief focus.  Fed chair Jerome Powell said that starting the US’s rate cutting cycle with a large move lower would protect against a downturn. However, there are some who worry that this is over-optimistic, and it does not take account of another flare up in inflation. This is why we expect gold to continue to trade with an upward bias in the medium term.

The bond market reaction to last night’s Fed meeting is interesting, US bond yields closed higher across the curve, including 2-year yields. Even though the Fed was more dovish than expected and downwardly revised their expectations for interest rates, the market was still ahead of the Fed, and was pricing in more interest rate cuts, particularly for this year. This means that the market reaction to a Fed meeting which was considered dovish, could lead to rising bond yields (bearish for bond prices) and a scaling back of rate cut expectations.

BOE: more predictable than the Fed

The focus will now shift to the Bank of England decision later today. There is only a 15% chance of a rate cut priced in by the swaps market, and we think it is highly unlikely that the BOE will cut rates today. The BOE is more predictable than other central banks, as it prefers to change interest rates at meetings where it delivers its monetary policy reports. Hence the first-rate cut came in August, and the market expects the second rate cut in November.

We do not think that the BOE will follow the Fed because service price inflation is still too high in the UK. There are a further 8 rate cuts priced in for the US in the coming months, in the UK, there are less than 6 cuts. This should keep recent dollar gains capped.

Watch any changes to quantitative tightening (QT)

The BOE is not expected to cut rates later today, there will be no press conference, so traders will be parsing the BOE’s statement and minutes from this meeting, to see if what the BOE could do next. There are two things worth watching: 1, if the BOE sounds concerned about the UK’; s growth outlook, this could take the shine off sterling. 2, The BOE could increase the size of its quantitative tightening programme to reduce the size of its bloated balance sheet. If this happens then it looks like the BOE will be giving with one hand (expected future rate cuts) and taking away with another (reducing the money supply). Ultimately, reducing the balance sheet should be anti-inflationary, so while cutting rates and reducing the balance sheet at the same time may seem contradictory, reducing the size of the balance sheet could offer more scope to cut interest rates down the line.

Why the reaction to the BOE meeting could be mild: the Fed

Overall, because of concerns about UK inflation and wage pressures we think that there is limited scope for the market to recalibrate their expectations for BOE rate cuts for the next year. This could limit the market reaction to this meeting. Instead, we expect the market Fed rate decision to be the biggest driver of financial markets as the market settles on what their decision means for asset prices for the long term.