Pound Rallies as BoE Considered 50bp - But Is There Really More in Store?

[DailyFx]

- Japanese Yen: All Industry largest drop in three years
- Euro: Strong Industrial New Orders blow past expectations
- Pound: Rallies as BoE considered 50bp
- CAD Dollar: LEI on tap

Pound Rallies as BoE Considered 50bp- But Is There Really More in Store?
The Bank of England Monetary Policy Committee voted unanimously for a 25bp rate hike at its meeting in May, surprising many traders who expected to hear at least one voice of dissent. However, perpetual dove David Blanchflower concurred with the majority view voting to take rates higher after the headline CPI rate breached 3.0 percent level in April. In fact the only point of debate was whether the BoE should raise a full 50bp rather than the 25bp ultimately agreed upon.
In the discussion on the proper setting of monetary policy preceding the vote, the Minutes read "For some members, the question was whether Bank Rate should be increased by 25 basis points or whether there was a case for a rise of 50 basis points - given the upside risks to inflation over the medium term and the buoyant outlook for growth and demand." Sterling rallied on the news as market once again considered the possibility of another BoE rate hike in the next few months.
However, we remain skeptical about the likelihood of any further tightening this summer. In contrast to the April numbers, May inflation data saw a considerable decline dropping from 3.1% to 2.8%. Furthermore UK Retail sales contracted sharply, registering their first negative reading in three months as higher interest rates and skyrocketing gasoline prices clearly dampened UK consumer spending. The UK central bank is correct to be concerned about the overheating, especially if global equity markets continue to rally. As the first "hedge fund" economy, UK is extremely leveraged to any additional gains in the financial markets which would translate to higher bonuses for workers in the City and will filter across the whole UK services sector. Should equity markets from Tokyo and Shanghai to London and New York remain "hot", UK economic growth will be as "buoyant" as the BoE expects, prompting another 25bp hike shortly. However, should capital markets cool, the slowdown in UK consumer demand, which is already evident will exacerbate and in that case the BoE is almost certain to remain stationary. For now sentiment favors the hawkish view, but the reality is far more data dependent than many pound bulls believe.
Meanwhile, the European Industrial sector continues to expand unimpeded. EZ Industrial New Orders printed far stronger than expected recording a 2.7% gain on month over month basis as higher exchange rates are apparently having minimal impact on demand. The news bodes well for the upcoming IFO survey due this Thursday and suggests that European economic growth in the second half of the year may exceed the consensus view. The EURUSD bounced from its lows set in a early London trade, but the pair continues to have difficulty making additional headway. For now the market is convinced that 4% will represent the cap in EZ interest rates as ECB carefully observes the impact of its expected rate hike before tightening further. However, should EZ data, especially German Retail Sales, continue to surprise to the upside, EZ rate expectations will ratchet higher and EURUSD could once again challenge the 1.3700 barrier.