GBP: How much is an independent BoE easing cycle worth? – ING
ING analysts suggest that in a world of low interest rates, it is no surprise to read analysis of rate differentials having lost their explanatory powers for exchange rates and that’s why GBP volatility on the back of recent BoE policy comments has proved a breath of fresh air for the GBP market.
“We choose to look at the differentials between the one-year OIS swap rates, priced one, two and three years’ forward. The 1Y1Y differential naturally is the first to react to any kind of change in relative BoE-Fed policy settings.”
“A decent relationship between the differentials and GBP/USD before Brexit and immediately post Brexit, as investors assessed the economic damage Brexit would cause. From 2018 onwards, however, that relationship has dramatically broken down as the market played ping-pong with the notion of a 'no deal' Brexit.”
“Notably, those differentials have been stuck in incredibly tight ranges since last summer, as the market had already priced in the Fed easing cycle, and the BoE remained in a Brexit moratorium. An independent BoE easing cycle would seem unlikely, and is not our call right now, but if the UK jobs data dramatically disappoints – 1Y1Y GBP OIS rates could at most fall 50 basis points.”
“The relationship between rate differentials is quite weak, but we estimate that a BoE-prompted 50 basis point widening in the 1Y1Y rate differential might knock 180 pips off cable. Were rate differentials to regain their pre-Brexit powers – e.g. returning to the relationship that existed in the first half of 2016 - then that 50bp widening in differentials on an independent BoE easing story would knock 720 pips off cable – according to our estimates.”