LONDON — An interest rate hike from the Bank of England would provide little more than a temporary boost to the beleaguered pound and investors should remain bearish on the currency, new research from Deutsche Bank argues. The analysis is counterintuitive because currencies normally rise in value as their central banks increase interest rates, encouraging savers to hold cash inside banks to collect that interest.
With a rate hike looking more likely than at virtually any other time in the past seven years, DB Macro Strategist Oliver Harvey wrote to clients on Tuesday to explore what that potential hike would mean for Britain’s currency, which has endured a horrible 12 months since the vote to leave the European Union last June.
Harvey has a four-part forecast for sterling in the event that the BoE moves rates up from 0.25% to the 0.5%. The rate last stood at 0.5% between the financial crisis and the bank’s emergency rate cut last August.
1. First up, Harvey notes, the pound is “highly sensitive to rate spreads.” As it stands, he says “correlations between the pound and front-end rates are on the rise.” That chart can be seen below:
2. Harvey’s second line of argument is that the pound does not generally see a great deal of strength in the lead-up periods where the bank is raising rates — so-called “hiking cycles,” but does do well once that period has started.
“Sterling performance around Bank of England hiking cycles has been ambiguous at best. Since the inflation targeting regime was adopted in 1992, the pound has weakened into hiking cycles three times out of five,” Harvey argues.
“By contrast, sterling tends to outperform after the cycle has already begun.”
3. The Deutsche strategist’s third point is that only the most optimistic forecaster would be likely to think that a rate hike from the bank anytime soon would signal the start of a new tightening cycle. Instead, any hike will effectively just be removing the emergency backstop put in place by the BoE after the Brexit vote.
“There is a difference between a withdrawal of last year’s emergency rate cut, and a full hiking cycle. Rhetoric from Haldane last week suggested that he saw the former as more appropriate,” Harvey writes.
“Market pricing has so far been consistent with this view, with the front-end selling off sharply, but little in the way of pricing further out the curve.”
Here’s the chart:
4. Finally, Deutsche Bank argues, “rising UK interest rates should be set against tightening policy elsewhere,” something that will effectively dampen any big upward moves in the UK exchange rate.
“If growth remains robust and the MPC hike, this should at least be partially offset by tighter ECB policy, in the form of tapering or a deposit rate hike.”
With all things considered, Deutsche Bank forecasts a jump in the value of sterling after any hike, but that jump will be shortlived.
“Given the above, we can’t see a late summer or autumn hike as providing anything more than a temporary support for the pound, and retain our bearish trade recommendation from May’s Blueprint.”
The bank does not provide a specific number in its forecast, but emphasises that it retains its bearish view on the currency.