Sterling is soaring on imaginary smooth-Brexit

No doubt about it — The Bank of England is hawkish, and it is ready to embark on a rate-hiking cycle. Sterling took an instant leap higher to the dollar, and 10-year gilt yields rose to the highest levels seen since April 2016.
Governor Mark Carney and the rest of the Monetary Policy Committee are leaving a lot to chance over Brexit. The pound is vulnerable to a nasty about-face.
If Brexit progress remains smooth, then a rate hike in May looks like about a 75 percent racing certainty, which is a jump from a 50/50 coin toss prior to Thursday’s announcement. A second rate increase is likely to follow in November. Already market expectations are outpacing the bank’s revised forward guidance for three rate hikes over three years.
But the bank’s confidence on the strength, or more accurately lack of slack, in the economy leaves it not so much data-dependent but Brexit-dependent. It is tough to see how officials can raise rates if negotiators fail to settle transition talks and start discussions on a trade deal. A delay — or even worse, a collapse — in Brexit talks would scupper the bank’s guidance.
One item gilt investors seem to have overlooked is that the BOE will reinvest 18.3 billion pounds ($25.7 billion) of its quantitative easing purchases in mid-March, courtesy of scheduled redemptions. That clearly outweighs the 12.5 billion pounds that the Debt Management Office will be selling during the rest of the quarter. From that perspective, the gain in gilt yields on the back of Carney’s hawkish remarks also look vulnerable to a sharp reversal.
With the end-March 2019 Brexit deadline little more than a year away, Carney has just set up a smooth-Brexit hurdle for the government to trip over. If Prime Minister Theresa May, or whoever is in charge next year, winds up with a hard Brexit, or no deal, all these rate-increase bets are off. In that case, sterling’s newfound strength and higher gilt yields will be a distant memory.

—Bloomberg