BoE Preview: Wait Until February for More QE

UK numbers have been quite good recently, much better than expected by most. Data yesterday showed BRC’s like-for-like sales climbed 2.2% in December, the best since April, and the RICS house price balance increased to -16%, the best since July 2010.

Consumer spending was quite strong in December, which makes the weaker November more tolerable. Last week, manufacturing and service PMIs both surprised on the upside, the latter even sending a clear expansionary signal. The UK data surprise indicator is almost as high as the US indicator and well above the European and Japanese ones, both in negative territory. Our preliminary estimate for Q4 growth is 0.0-0.2%, which means that the UK might not be in recession contrary to popular belief.

BoE will not increase asset purchase target in January
It is in our view unlikely the Bank of England (BoE) will increase the asset purchase target when the Monetary Policy committee ends its two-day meeting on Thursday. As we pointed out in our last BoE preview, the BoE acknowledges the economy needs more stimulus but it might be afraid the market cannot absorb accelerated Gilt buying: “Market capacity made it difficult to increase the monthly rate of purchases substantially above what was already under way” the latest minutes said. We interpret this as meaning that more QE will surely come but not at a ‘run rate’, i.e. the current speed, around £5bn per week, will be maintained going forward.

We think the Bank of England will continue to buy Gilts throughout most of 2012. The first increase will be announced in January and could be either £50bn or £75bn. The former would signal the Bank is levelling off, while the latter would indicate that stimulus continues unabated and more might be coming. We think total asset purchases will amount to £400bn by end-2012. It is difficult to estimate the total programme but we expect the economy to expand in H2 12 after having backpedalled for some time. Our base rate indicator will be an important tool.

Sell September Euribor Libor spread
Unlike in Europe, the liquidity situation in UK money markets has not improved. UK Libor rates have continued to rise, while Euribor rates have fallen, partly reflecting a more dovish ECB. We do not think the BoE will continue ignoring Libor rates creeping higher when keeping the base rate unchanged and doing more QE. As we have previously argued, a new Special Liquidity Scheme could improve the situation. Combining this with Euribor fixings probably not falling much further as the ECB might be done cutting rates for now, we see good value in buying the September sterling future against selling the Euribor future at 12bp for a -10bp target and with a stop at 25bp. After having been negative for most of 2011, this spread has been positive since November but recently
stabilised somewhat. With the BoE probably already moving closer to addressing the liquidity situation in the UK and the ECB focusing more on non-standard measures from here on, we find it likely that the Euribor-Libor FRA spreads come in over the coming weeks.