GBP experienced a vicious short covering rally last week sparked by speculation the Bank of England (BOE) may pause its asset purchase program. There are two key event risks this week that could inject additional volatility in GBP trade, Wednesday's release of the Monetary Policy Committee (MPC) minutes for the October BOE policy meeting and Friday's release of UK advanced Q3 GDP. The MPC minutes are a detailed record of the BOE's most recent policy meeting. The minutes include economic forecasts and a breakdown of how the policy board members voted on BOE interest rate and policy decisions. The main focus for the October MPC minutes will be the BOE's debate on quantitative ease and their growth and inflation forecasts.
In August, the MPC was divided over the issue of whether to expand quantitative ease with three board members including BOE Governor King calling for an expansion of the BOE asset purchases from £175 bln to £200 bln. In September the MPC voted unanimously to maintain the current level of asset purchases at £175 bln. Recent statements from two MPC board members, Fisher and Posen suggest that the MPC board may be once again divided over whether asset purchases should be paused or expanded. Fischer says that quantitative ease is working and he suggested that the BOE may pause in its asset purchase program at the November policy meeting. Posen appeared to indicate that he would support a decision to expand quantitative ease. Fischer's comments sparked last week's sharp recovery in the GBP. Posen's comments limited GBP gains in Monday's trade. If the October MPC minutes suggest that the BOE policy board is once again divided about quantitative ease the minutes could spark fresh selling of the GBP. If the October MPC minutes indicate that the BOE is moving closer towards a pause in the quantitative ease program the GBP could experience a more substantial short covering rally. A pause in BOE quantitative ease would be the most positive scenario for the GBP.
There is one additional issue that the trade will be interested in: whether the MPC is considering a cut in its deposit rate it pays on commercial bank deposits. There had been speculation towards the end of the summer that the BOE was considering cutting the deposit rate to try to increase liquidity in the financial markets. The main argument against cutting the deposit rate is that it makes banks less profitable and possibly less willing to lend. The October MPC minutes may reveal if the BOE is still considering a cut in the deposit rate. A cut in the deposit rate would be negative for the GBP. The trade will also be looking at how board members view UK growth and inflation outlook. An upgrade of MPC growth and inflation outlook could generate speculation that the BOE is nearing the end of quantitative ease.
GBP policy outlook coupled with speculation about the end of the UK recession are the key drivers for GBP price direction. Recent UK economic data suggest that the UK economy has bottomed with the housing market and industrial production showing signs of stabilization but unemployment continues to rise. Although the data suggest that the UK economy is emerging from recession it is far from clear if the recovery is sustainable. The MPC may want to see Friday's release of UK advanced GDP before they make a decision on whether to expand or pause quantitative ease. UK Q3 advanced GDP is expected to show growth has returned to the UK economy. UK Q3 GDP is expected to rise 0 .2% m/m and improve to -4.5% y/y from -5.5%y/y in Q2. The improvement in UK GDP will partly reflect improvement in UK manufacturing and services PMI. A positive reading on UK Q3 GDP will add support to the GBP.