Bank of England responds to the Brexit shock – Goldman Sachs

Research Team at Goldman Sachs, suggests that their UK economist, Andrew Benito, expects the Bank of England to cut Bank Rate by 25bp at its August policy meeting.

Key Quotes

“He thinks the policy rate will not rise before end-2019 and that the BoE will restart asset purchases (£100bn over a period of six months in a mix of Gilts, corporate bonds and other assets). This, combined with an almost unchanged outlook for the US monetary policy stance that our US economists expect, implies a sizeable widening of USD-GBP interest rate spreads to 3% by the end of 2019 (or higher if the additional liquidity injected with asset purchases is accounted for).

A legitimate question relates to how much the UK’s more expansionary monetary policy stance has already been incorporated in asset prices. On June 30, Cable dropped over one big figure as Governor Carney hinted at additional stimulus in his first speech since the Brexit vote, price action that to us suggests ample downside in Cable should stimulus materialize.

The Sonia curve has shifted downward since June 23 and the 1-month 1-year forward Sonia rate is 0.11%, indicating that the market expects about 40bp in policy rate cuts. But, the 2-year and 5-year interest rate differentials between USD and GBP swap rates are 26bp and 40bp (up only about 20bp from the close on June 23). This suggests to us that the market is not discounting the easing effect of asset purchases, the persistence of easier monetary conditions in the UK, and the US-UK monetary policy divergence that we expect nearly as much as it should.

Next week, we expect the BoE to provide a further indication of the scope of the conventional and unconventional monetary policy measures we expect. This will be the catalyst for a further downward move in Sterling.”