Outlook For GBP Still Firm, But BoE Has Options Other Than Interest Rates

MahiFX Markets Commentary

With the UK property market, particularly in the southeast of the country, in robust health there are widespread expectations of an interest rate rise from the Bank of England, which is supporting GBP – but there are tools other than interest rates at the BoE's disposal for cooling the property market.

According to the Office of National Statistics UK property prices rose 8% in the year to the end of March with growing concerns that it could morph into a bubble. Even the Bank of England has  sounded warnings over the strength of the property market.

With the UK economy also looking a lot healthier there are widespread expectations of a rate rise sometime in the Spring of 2015. It's an expectation, which the Bank of England has been muddying despite apparently being concerned about the property market. There certainly appears to be disagreement between MPC members over prospects for interest rates.

However, if property prices continue to make strong gains, as is fairly likely, there will be pressure on the Bank of England to intervene to slow them down.

Move above GBP/USD 1.70 would likely trigger BoE verbal intervention

Concern over the rest of the economy

The concern for the Bank of England is that a rate rise could hurt other parts of the economy, such as the business sector. It is also likely to send GBP soaring against the USD and EUR. This has been a familiar dilemma for the BoE over the decades.

In an ideal world the BoE would like to slow the pace of property price appreciation without sending   GBP higher and hurting exports and raising the cost of credit to the rest of the economy. Indeed, the BoE would probably grow concerned about exchange rates above GBPUSD 1.70. 

CPI below 2% suggests the rest of the economy probably doesn't need a dose of dearer money. 

But the BoE may have a solution. Following the financial crisis it amassed a considerable array of new regulatory powers. Instead of interest rates the BoE could raise the lending criteria for mortgage providers making their loans more expensive. In theory this shouldn't impact the cost of credit to the rest of the economy, particularly for businesses.

Given the risks to the rest of the economy the BoE is likely to first try the regulatory route to slow a potential runaway property boom. If the approach worked it would likely remove some support for GBP and delay an interest rate rise for the rest of the economy until late 2015 early 2016.   

That would certainly suit the ruling Conservative / Liberal Democratic coalition government, which will be fighting a general election by May 2015.  

By Justin Pugsley, Markets Analyst MahiFX

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