Why the BoE Should Cut 50bps

When it comes to weak currencies, all we hear about is the dollar, yet another significant risk lies with one of its oldest allies. While the Fed has been aggressively cutting rates, the BoE has been sitting on the sidelines to a certain extent with rates still sitting at 5.00%. This won’t last long.

At the end of last year I had the pleasure of meeting Ashraf Laidi while I was working at CMC Markets. He stated, and with strong conviction, that the Pound in 2008 would be the USD of 2007 - and boy is it shaping up that way.

A few months later and everything appears to be lining up. The 12th of November marks the recent peak and since then, although the U.S. dollar has been falling, the pound has been falling faster.

The Fed Running out of Options

While I do expect the Fed to continue to cut rates, they are starting to run into other obstacles thanks to their terrible balance sheet. Recently Moody’s warned that should the US have to bail out some of their hardest hit GSE’s, it could compromise their coveted AAA rating. The BoE on the other hand has been given the go-ahead by Moody’s, stating today that the situation with Northern Rock will not affect their rating and that they could give more bank support without a risk of downgrade.

Although both countries started the crisis out with high debt-to-gdp ratios, the U.S actually faired better in this regard, thanks largely to its strong economy. Should the economy slow, this number can move up quickly for 2 reasons. Firstly, lower GDP will increase the ratio, secondly lower gdp will decrease tax receipts and force the government to dig deeper into their pockets to cover expenses. Due to the size of the U.S relative to the UK (U.S GDP is almost 7 times that of the UK), a slowdown will likely hit their balance sheet and the ratios Moody’s monitors harder than the UK. But a lot of that is already being priced in.

UK debt - 43.8% of GDP at the end of 2007

US debt - 36.8% of GDP at end of 2007

Consumers & Housing

With all of the talk of the U.S consumer and their housing woes, don’t forget what’s happened in the UK. Taking a look at the RICS Housing Survey, which was published this week reveals a scary fact. Although the move is happening in a more orderly fashion, the housing prices are clearly pointing in one direction. Added to that, the UK consumer credit situation is just as bad as the U.S. In February, UK citizens added 9.8 billion pounds of borrowing which was higher than January and the prior 6 month average. The U.S. on the other hand added a total of $5.2 billion. Based on the relative populations, it isn’t necessary to do the math, but you can clearly see that credit is flowing easier in the UK. Possibly why the BoE is still holding off on rate cuts?

Why the BoE Should Cut 50bps

Assuming the outlook of an economy that continues to weaken, both in the U.S and the U.K, it is likely that we will see rate cuts from both countries moving forward. However, the BoE has the opportunity to move ahead of the game here (to an extent as the slowing has already begun). Last week the BoE gave us a 25bps cut, and it is likely that we see this sort of easing continue month to month, however I would like to see a more aggressive push now. With the terrible housing numbers on Monday and the below expectation inflation numbers today, I think that there is a possibility that we will see a 50bps cut next month. Should that not happen, I expect to see a 25bps cut in each of the next 2 months with more rate cuts to come this year.

Comments

[Ames Tiedeman:]

England needs to do something. They now have the worst housing market since 1978. The Pound is very strong so they can afford to cut rates.

2008 Apr 16 07:07 AM