Dovish BoE applies more QE - Norges Bank holds its horses
Bank of England will most likely lift the asset purchase target by GBP50bn to GBP325bn at the February meeting on monetary policy. Quantitative easing was restarted in October and the Bank of England has been buying Gilts worth 75bn over the past four months. Yields have fallen but the economy has not recovered and the UK is probably now in recession like the Eurozone, just slightly milder.
Private consumption has not picked up yet and the government’s austerity measures are kicking in with unemployment creeping higher. We reckon financial markets in general expect more monetary stimulus, which the Bank of England of course knows and accordingly will deliver, as it has not communicated that the bond buying is coming to an end. We guess the Bank of England in total will have bought Gilts worth GBP400bn by the end of the year. The asset purchases are essentially financed by printing money and are not sterilised which means QE tends to depreciate sterling. The only reason sterling has not weakened over the past months is because other factors such as the Eurozone crisis and general risk sentiment have dominated. That can however easily change.
Norges Bank took most by surprise when it pre-emptively slashed rates by 50bp in mid- December as a response to the turbulence in financial markets and outlook for global growth. We do not think the next meeting on monetary policy will be that dramatic as emergency rates are not required and 2012 will not be 2009 all over again. The Eurozone recession may well slow down the Norwegian upswing, but the economy will grow more than 2% this year and slightly less next year. High oil prices are fuelling further strong oil investment, which is lessening the impact of the crisis and limiting the downside risk to the Norwegian economy. Improved terms of trade also mean strong growth in real household disposable income, which is being amplified by low interest rates and inflation.
GBP/NOK can continue lower
After tenacious increase over the past half year, GBP/NOK has flattened out and begun to form a downtrend. The December high of 9.37 may not be seen again. The options market still favours call options over put options, but the 3M 25D risk reversal has declined to the lowest level since early June, when GBP/NOK was trading around 8.80 and even fell below 8.60 in July. GBP/NOK followed oil prices closely in H2 2011, but has not reacted to the latest move higher in crude oil, which suggests the pair is somewhat too high.
The recent risk rally is not reflected in the spot rate either. From a G10 perspective, short GBP/NOK offers decent carry, around some 140bp, and could end up yielding even more when Norges Bank clearly communicates that further rate cuts are not required and BoE keeps on vacuuming the Gilt market. Please note that GBP/NOK is negatively correlated with EUR/USD, i.e. if EUR/USD continues higher, GBP/NOK will dip lower.