Last week there was a significant divergence between the FOMC policy statement and recent BOE policy action. The FOMC indicated that the US economy was leveling out and the FOMC plans to gradually reduce the purchase of bonds. This is the beginning of the FOMC's exit strategy from quantitative ease. The BOE elected to expand quantitative ease by Â£50 to Â£175 bln after the release of BOE's Quarterly Inflation Report which said inflation could fall below 1%. A soft UK CPI report may encourage the BOE to expand quantitative ease by another GBP25 bln at the next policy meeting on September 10th.
The BOE policy minutes will an important to gauge of how far the BOE may be willing to go in regard to quantitative ease and expanding the UK money supply and lending. There is emerging fear that the recent rally in global equities and commodities is not supported by fundamentals and that the global recovery may be at risk if central banks begin to look for exit strategies from quantitative ease. The main source of recent global growth has been government spending and easy central bank monetary policy. As government spending is about to lapse and some central banks are discussing possible exit strategies from quantitative ease, the global recovery is in doubt. Doubt about the global recovery and concern that central banks will exit quantitative ease too soonÂ has emerged as a key driver for the markets. If the BOE minutes signal the central bank is open to another expansion of quantitative ease it may help to relieve some of the fears about the global recovery and about central banks taking away liquidity too soon. GBP has been under pressure since the BOE announced the expansion of QE and extended losses as equity markets declined on doubts about the global recovery.
Equity markets have declined from a five month rally and USD is rebounding from the years low. Equity markets are pressured and USD supported by a pullback in risk appetite. Uncertainty about the outlook for the global recovery is emerging as the main driving factor in FX trade. Investors continue to try to balance safety versus risk appetite. There is concern that the recent run-up in equities and recovery in global economy was the result of stimulus spending and central bank quantitative ease. The greatest risk to the global recovery is central banks remove liquidity too soon and choke the recovery. Once stimulus is withdrawn the global economy may weaken and be at risk to a double dip recession. How the BOE responds to diminishing UK inflation risk is key to GBP price direction as the BOE is the least likely of the G-7 central banks to end quantitative ease anytime soon. GBP may experience additional selling pressure if UK inflation data is weak.