More UK easing to come, short GBP/USD – RBS

James Nelligan, Research Analyst at RBS, suggests that with the BoE Bank Rate and gilt yields already at historic lows, we expect this easing package to have diminishing marginal returns on the economy.

Key Quotes

“In our view, the problem isn’t the supply of credit, it’s the demand for credit and more easing will be needed later this year. This may potentially come in the form of looser fiscal policy at the Autumn Statement and/or further Bank Rate cuts (the lower bound is probably 5-10bps).

We have seen in Europe and Japan that more focus on QE over deposit rate cuts leads to involuntary currency strength. In Europe and Japan the central bank is seen to be very close to the lower bound, so nominal short end rates can’t go much lower, and inflation expectations have been coming down, so real interest rates rise.

In the case of the UK, if the BoE hits the lower bound, real rates likely won’t rise because inflation is projected to rise. We forecast headline inflation to rise to 1.5% y/y by the end of 2016. Real interest rates will be falling in the UK, weakening sterling. Previous episodes of BoE QE were a reaction to weak economic data, among other things, and in 2011 cable experienced a relief rally following the announcement of QE.

Today we believe the majority of weak data is ahead of us and so the idea of sterling experiencing a relief rally is somewhat less plausible. The UK data calendar is quite light this week, but RBS UK Economics Desk Strategist Ross Walker expects further declines in retail sales and housing market surveys.”