Massive FX volatility on the horizon? BoE attitude and job losses mean clear path for the B-bookers

The Bank of England will announce its latest monetary policy decision tomorrow, but investors and policymakers will be focused on whether Threadneedle Street has become more pessimistic about the UK economy.

Two months ago, the BoE’s monetary policy committee (MPC) raised some eyebrows when it said the UK economy would suffer an unprecedented crash but would bounce back quickly in what has been dubbed a ‘V-shaped’ recovery.

Since then, the economic data has in fact been a bit more positive than the Bank envisaged. But a quick rebound has been called into question as more unemployment is on the horizon.

Investors will also keep a keen eye on what the Bank says about monetary policy. It is expected to leave rates on hold at 0.1 per cent and maintain its target of £745 billion of bond-buying. But it could say something about negative interest rates, which it is weighing up for the first time. Bond buying is often as dangerous as printing money.

Bank of England very bearish on growth

In May, the Bank of England did not release official forecasts but published a “plausible illustrative economic scenario”.

It said the UK economy would shrink by 14 per cent in 2020 in its worst year since the 1700s due to the absurd lockdown forced upon the nation. The Bank foresaw a 25 per cent contraction in the second quarter.

However, GDP data has since beaten the Bank’s expectations. MPC member and chief economist Andy Haskel said an earlier easing of the lockdown was pointing to a less severe drop in the second quarter. That could lead the MPC to improve its growth forecast for 2020.

Yet the Bank said in May that the UK economy could well grow by an impressive 15 per cent in 2021. It said it would quickly regain its pre-lockdown size.

This could almost certainly be written off as hyperbole, because let’s face it, the markets – especially the currency markets – are going to go ballistic when the furlough scheme ends and employers are faced with having to pay their staff to sit at home, which will lead to many companies making widespread redundancies because companies generally don’t furlough for months at a time employees that are key to the business.

B Book brokers raked it in, and likely to once again

Perhaps many already cash-strapped companies will decide that if they can do without certain employees for most of the year, they don’t need to keep them on the payroll.

This further unemployment drive in the United Kingdom would then echo that in the United States where there was no furlough scheme and over 45 million people found themselves out of a job with no income in a very short space of time this year.

Thus, the FX market volatility will likely rise again, as it did at the beginning of the closedown period, causing many B-Book brokerages to make a fortune.

Economists were sceptical at the time of the Bank of England’s initial analysis, and have become more so. “The better near-term outlook will be offset by a weaker medium-term picture,” said Sanjay Raja, economist at Deutsche Bank.

Bank of England UK economy interest rate decision

Economists worry that unemployment and social distancing could hold back growth in the UK economy.

The second is that “business activity remains weak” three months on from April’s economic collapse. “Overall sales in the economy have only gradually picked up,” Raja said. “The number of businesses still trading remain low.”

The third and arguably the most important is that unemployment is set to climb and consumer confidence remain low as a result. The job retention scheme that has supported more than 9million workers is set to end in October. “The reversal in fiscal stimulus will act as another dampener to growth at the end of the year,” Raja said.

Analysts expect the Bank to hold off from tinkering with monetary policy, which is currently ultra-loose. The Bank rate is set to stay at its current record low of 0.1 per cent. And planned asset purchases are expected to stay steady at £745bn.

Howard Archer, chief economic adviser to the EY Item Club said that it is “likely that the MPC will sit tight for the time being before providing further stimulus action”. He said the economy is currently benefiting from the recent easing of lockdown measures and tens of billions of pounds of fiscal stimulus from the chancellor.

Yet analysts are broadly expecting the Bank to increase stimulus towards the end of the year.

Anna Titareva, European economist at UBS, said: “An increase in job losses seems inevitable.” She said the MPC might consider making the terms of its ultra-cheap lending to banks more generous in the autumn or winter “or increasing the pace or size of the asset purchases”.

Mr Archer said he expected the Bank to announce more asset purchases worth £100bn “either at its September or – more likely – November meetings”.

Negative interest rates

Bank of England governor Andrew Bailey in May said negative interest rates were under “active review” for the first time.

It is currently reviewing the “effective lower bound” (ELB). That is the point at which an interest rate cut is no longer beneficial to the economy.

Raja said: “We think a decision on the ELB is near, and we should likely hear the outcome either at the August or September MPC meetings.”

If this is not a recipe for volatility, especially when considering that the British Pound may well become the world’s reference currency in place of the dollar, then I’m a hobgoblin.