The Bank of England acted in line with expectations, leaving the interest rate and the volume of asset purchases unchanged. In its report, the regulator noted that consumer demand fell significantly in the first quarter, which affected the pace of economic growth, given that consumption accounts for 65% of the UK GDP. The reason for the decline was the devaluation of the pound, triggered by the country’s exit from the EU, which had both positive and negative consequences for the economy.
The devaluation of the currency contributed to the acceleration of inflation, which reached 2.3% in April, but the lagging growth rates of salaries naturally pulled the purchasing power of the population down. On the other hand, the weak pound began to stimulate foreign trade, and, consequently, business investments, which account for 17% of UK GDP. This compensated for the decline in consumer demand, which explains the regulator’s “belief” that the economic situation is under control.
The wait-and-see stance of the Central Bank can be explained by the fact that a possible loss of the EU single market and new trading partnerships of independent Britain will entail changes in the labour market and may be associated with a slowdown in the growth of wages. The normalisation of inflation, that is the pursuit of a 2% target, urges the need to raise rates, which will inevitably lead to an increase in unemployment and, probably, to an even weaker income growth. The regulator will probably have to cope with an inflation that rises above the target level, if it keeps rates at the current level, but as the central bank noted in its report, if the economy follows May’s projection, the likelihood of tightening the policy may increase.
Data on production and trade balance of the UK were not as rosy as expected. The growth rates of industrial and manufacturing production slowed in annual terms and the trade balance deficit increased, although the consensus forecast predicted a further decline. The probability of the Bank of England keeping rates on hold at the next meeting, focusing precisely on these statistics, has increased, so the pound is likely to be hit by another wave of selloff. The loss of GBPUSD level of 1.2850 could be a signal for further decline. The net position on the pound according to CFTC data is -81.4K contracts.
VIX, the index of “fear” in the markets rose higher, after falling below the historically significant 10-point mark. An indicative response was shown by defensive assets, such as rising gold, yen and Swiss franc. The US dollar is preparing for the release of inflation data, which, as expected, could affect the Fed’s June decision on the interest rate. The weighted average dollar index is trading near the level of 99.50, in anticipation of the release of this important macroeconomic indicator.