What is the Shadow BoE Monetary Policy Committee?

Since the beginning of the month, the British pound has staged a dramatic rally against the U.S. dollar on the belief that the Bank of England will have to raise interest rates very soon. In slightly more than a month, the GBP/USD has rallied from a low of 1.54 to a high above 1.6250. Interest rate futures show that investors are looking for 3 quarter point rate hikes from the BoE this year, which would make them one of the most aggressive G7 central banks. However this hawkish expectation from investors is completely at odds with the sentiment in the Bank of England. Monetary policy makers are convinced that the rise in inflation pressures is temporary and therefore does not necessitate action by the central bank. However two members have already dissented from this majority view and more could follow.

The Bank of England’s monetary policy is in focus this week because they have a monetary policy meeting but no changes are expected to made. However the pound has held onto its gains after the Shadow Monetary Policy Committee voted 5-4 to raise interest rates in Feb. At this point, you may wonder, who makes up the Shadow MPC and whether they even matter at all.

The Shadow Monetary Policy Committee (SMPC) is a group of independent economists in the U.K. that meet at the Institute of Economic Affairs, to discuss the state of the international and British economies. Their first meeting was held in 1997 and have met once a month since then. The decisions and minutes of the SMPC are published a few days before the Bank of England’s own interest rate decision and are oftentimes referred to as a guide for what the MPC could do. Like the Monetary Policy Committee, there are 9 voters at each meeting.

For the first time in this cycle, the Shadow Monetary Policy Committee has voted to raise interest rates. The decision was not unanimous with 5 members voting for a rate hike and 4 voting against it. Although the shadow council failed to predict the last 2 rate cuts by the MPC, their decisions matter because it helps investors get a sense of what intelligent economists who follow the U.K. economy closely are thinking. According to the SMPC, there were 3 main reasons why the 5 members voted for a rate hike:

1. Threat to the Credibility of the Inflation Fighting Mandate of the Central Bank

2. They believe that the greater risk for the global economy is overheating than depression

3. They believed that the slide in the GBP reflected the laxity of the U.K.’s monetary policy compared to other countries

Although the chance of the BoE actually raising interest rates is slim, what the SMPC votes tell us is that we are getting closer to a possible rate hike. This means that hawkish comments from central bank officials could easily set off additional gains in the GBP/USD that could cause the currency pair to challenge its November highs.

Charting the GBPUSD: Head and Shoulders Update

The weak UK GDP number caused the GBP/USD to sell off aggressively today, breaking the uptrend in the currency pair. Earlier this week, I posted a chart about a head and shoulders formation that could be forming in the GBP/USD. At the time, I said that it was a bit premature but after today’s price action, its certainly looking like this could be the start of more significant losses in the currency. I’m not so greedy and will be happy with a move to 1.5650, but where do you see the neckline?

Head and Shoulders in GBPUSD?

After rallying for 9 straight trading days, the GBP/USD has finally pulled back. In my Charting the GBP/USD post yesterday, I showed a chart illustrating the extremeness of the move in the currency and talked about how it was prime for a correction. Typically when moves become this overextended, a correction of AT LEAST 100 pips is possible in the GBP/USD and that is what we have seen today. However, the sell-off today has formed what could be a very early Right shoulder in the GBP/USD. Take a look at the following chart and tell me if you see a head and shoulders pattern forming.

Charting the GBP: Due for a Correction

The British pound is currently enjoying its longest rally since July of last year. Nine straight days of gains has taken the currency from 1.54 to a high above 1.60. When a move in a currency pair becomes this overextended, it screams for a correction. Whether this correction is large or small really depends on the catalyst but when it comes to the GBP/USD, the correction is rarely less than 100 pips. Over the next 48 hours, there are TWO potential catalysts for a turn in the pound – Chinese data and UK retail sales. Weaker than expected Chinese economic data could easily trigger a wave of risk aversion that sends investors flocking into the U.S. data. Even if the data is good, retail sales on Friday could be bad – winter storms took a meaningful drag on consumer spending according to the BRC retail sales report. Should the GBP/USD fall, support will be at 1.5850. As long as this level holds, the uptrend will remain intact. Higher inflationary pressures provide fundamental support for the rally in the pound so the currency pair will not give up its gains easily.

Anyone have their tin hats on?