A night of swift change at the top of British politics will play out in markets on Thursday ahead of the latest Bank of England decision on interest rates.
The initial reaction to Theresa May’s new cabinet seems favourable with the FTSE 100 looking set for a much stronger open than other European stock indices.
Mrs May’s early cabinet appointments confer stability through Phillip Hammond as Chancellor of the Exchequer but also daring and an interest in reaching out to those who favoured leaving the European Union through Boris Johnson as Foreign Minister.
George Osborne has been turfed out of the Treasury with Theresa May clearly looking to make a fresh start on the UK economy. Mr Osborne’s theme of austerity stabilised the UK economy after the crisis but a recovery that has seen the divide between rich and poor increase jars against the new Prime Minister’s vision of making the economy work for everyone.
Theresa May abandoning Osborne’s controversial plan to balance the budget by 2020 is sensible given the unlikelihood of achieving it but leaves the country vulnerable in the next downturn.
Philip Hammond is considered a fiscal hawk and will likely be seen positively by investors who might have been concerned about Theresa May’s plan to reduce austerity and take on corporate governance rules.
Besides more new appointments to the government, the Bank of England rate decision will be the main event of the day. Expectations are for a 0.25 bps cut to the headline interest rate with an outside chance of an extension of quantitative easing.
The threat of Brexit and Mark Carney’s desire to get out in front of any problems by easing monetary policy is obviously the reason for the consensus belief. However, markets are perhaps under-pricing the Bank of England’s concern over the negative impact of lowering interest rates on bank profitability.
Lower rates could go very wrong. Squeezed banks may choose not to lend to the economy and thus tighten credit conditions. With gily yields already much lower than pre-Brexit and the political picture stabilising, it would seem more prudent to at least wait until the release of inflation forecasts at the August meeting.
EURUSD – The euro is sitting in the middle of a 200-pip range between 1.10 and 1.12. The large downswing on June 24 through the bottom of its old trading range implies further downside towards 1.08.
GBPUSD – Bullish divergence has played out with a 500-pip upswing from the low of 1.28 but another test closer to the lows may be needed to establish a bottom. A break of 1.28 could target the 1.25 handle.
EURGBP – Euro-Sterling has found interim support at 0.83. A break lower could target the old swing high at 0.8117, though the uptrend favours another move higher to the high above 0.86.
USDJPY – Having failed twice at 100, dollar-yen has rebounded to 105. Strong round number support combined with a long downtrend could see a new trading range develop at current levels.
