The UK Financial Policy Committee (FPC) and the BoE announced that its Funding for Lending Scheme (FLS) will no longer provide a subsidy for banks to lend for mortgages from January, a move intended to lean against the strong rise witnessed in UK house prices.
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The fact the decision reverses part of the BoE’s unconventional monetary measures has seen some argue that it represents a tightening of monetary conditions and that it can be viewed as the precursor to a rise in UK interest rates.
The rally in sterling, and the slide in short sterling futures, seemed to reflect that view, with currency investors focusing on the fact the decision highlighted the strength of the UK’s emerging economic recovery and thus the prospect that rate increases might follow sooner than the market had thought.
However, Derek Halpenny, head of FX strategy at Bank of Tokyo Mitsubishi-UFJ, takes a different view.
He says the fact the FPC exists and is now being used to manage the economy is telling in that it is a clear sign of the change taking place in terms of UK macro-economic policy management.
“This essentially means that some of the onus that traditionally rested on interest rates to manage policy has been shifted to macro-prudential policies,” says Halpenny.
He believes the decision strengthens the BoE’s forward guidance and means there’s a greater chance interest rates can remain lower for longer.
“If mortgage lenders are to be believed that mortgage rates will rise next year, well then there is less need for an actual rate increase,” adds Halpenny.
“The pound has now come a long way and looks very stretched at current levels.”
Brian Martin, senior strategist at ANZ, agrees that it is arguable that the decision on the FLS pushes back the timing of any UK rate rise, as it reduces the probability of excessive imbalances in the British economy.
“The impact of the decision to end the FLS mortgage incentive should, at the margin, help to anchor inflation expectations and actual inflation,” he says.
“In that regard, the measure reinforces the Bank of England’s forward guidance and, if anything, should help push back the timing of interest rate rises. It could be argued that that is negative for sterling.”
Similarly, however, Martin says more sustainable growth – thanks to the reduction in the chance of a UK housing bubble developing – and the implication that holds for the country’s balance-of-payments position could be argued as positive for the pound.
Indeed, there is evidence that the UK economic recovery is becoming more broad-based, with recent PMI and CBI surveys confirming that to be the case. The CBI trends survey for November, for example, reported total orders are at the highest level since 1995.
Martin advises watching the price action in sterling closely, as the FLS change could be interpreted either way.
“What we do know is that the Bank of England implicitly has welcomed a stronger pound, the UK recovery remains ahead in the global recovery cycle and that retracements in sterling, therefore, should be limited,” he says.
Further seasonal cheer could also boost sterling bulls, especially against the dollar.
The pound generally tends to perform well against the dollar in December, especially in the first half of the month before liquidity dries up.
Of course, as Steve Barrow, head of FX strategy at Standard Bank notes, seasonality in currencies is something of a moot point.
“There’s the argument that there can’t really be any seasonality because, if it were obvious, the market would efficiently anticipate the seasonality to an extent that the seasonality could no longer exist,” he says.
“But perhaps that’s exactly why sterling/dollar is rallying now, as traders and investors anticipate seasonal demand in December.”
Exactly why December produces seasonality in GBPUSD, and also EURUSD, is hard to pin down.
It could be a result of profit repatriation by UK companies as they prepare to pay corporation tax in January. Equally, it could be because December is usually quiet in terms of newsflow, as policy speeches wane and international policymaker meetings ebb.
In addition, liquidity thins out as the market winds down for Christmas. Thus a relatively quiet period for speculative flows in the market might open the way for more traditional, and seasonal, factors to dominate market movements.
Of course, seasonality does not guarantee that sterling will rise against the dollar every December – it just means the pound’s performance tends to be stronger than in the other 11 months of the year.
As Barrow observes: “Just like the weather, we know that summer months are usually warmer than winter months, but we can’t guarantee it will be hot.”
Still, for sterling bulls looking at the positive implications for the UK economy from the BoE’s decision to shut down the FLS, it is another reason to be confident the pound can sustain its recent sharp gains.