The Growth Of Deflationary Risks Is Putting Pressure On The U.K. Interest Rates

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Summary

The combination of circumstances in the manufacturing sector leads to the further fall of the pound.

The drop in domestic demand may adversely affect the FDI and the inflation rate.

BoE will have to resort to stronger measures than the countercyclical capital buffer of risk-weighted assets.

Despite the benefits that will receive British exporters by reducing production costs due to lower value pound, they will have to pass through some difficulties. The essence of difficulties lies in the fact that after the fall of the pound, manufacturers will be forced to sell their products at lower prices, as production capacity, raw materials and, in part, wages have been funded at a higher pound value. I think that these factors, net of pay, will affect the Q2 2016 earnings, as the fall in the exchange rate of pound immediately led to the reduction of profitability of exporters.

The negative impact will be expressed in the reduction of the indicators values of business efficiency, which is leading to a decrease in FDI and a further decline of the pound, respectively.

Moreover, recent data on economic performance in the manufacturing sector, which includes both exporters and companies focused on the domestic market, indicates that British manufacturers will face an additional problem. The combination of the indicators dynamics of UK factory orders and UK capacity utilization in the first two-quarters of 2016, in my opinion, indicates that the company's manufacturing sector will face with more rapid decline in demand for their goods. This is because the declining demand, as reflected in UK capacity utilization indicator, will meet with an increase in supply, as reflected in the UK factory orders indicator, at the beginning of the third quarter. Consequently, these factors will lead to a drop in prices of these products to maintain their competitiveness.

( Source: tradingeconomics)

So I think the rise in goods and services prices due to the fall of the pound is a temporary phenomenon. Inhibition of growth of domestic demand, which is reflected in the negative values of consumer sentiment indicator and the United Kingdom Business Confidence index, may increase due to the rise in the cost of imported goods and services after the fall of the pound. Thus, UK business can greatly suffer if the BoE stimulus will be weak and ineffective.

(Source: tradingeconomics)

On July 5, UK FPC has reduced the value of countercyclical capital buffer for UK exposures from 0,5 to 0. Authorities reported that this measure would increase the possible volume of lending by 150 billion pounds ($ 197 billion). However, I think this action will not bring significant results since the unfavorable economic environment of UK will contribute to a drop in FDI due to lower values of UK business efficiency indicators. Eventually, inflation will be under downward pressure, and the BoE will be forced to resort to other, more considerable measures.

I think the above reasons will lead to a reduction of the current inflation rate, and one should expect additional incentives by BoE and a further decrease in the pound value against USD during July and August 2016. Therefore, would be reasonable short selling FXB and GBB during the first half of Q3 2016.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.