Bank of England Preview: How Will The Pound (GBP) React?

[MongiIG]

GBP/USD, BOE PRICE ANALYSIS & NEWS

• BoE Expected to Raise Bank Rate to 1%
• Focus is on Vote Split and Asset Sales Outlook

JOIN OUR LIVE BOE COVERAGE

SUMMARY: The Bank of England is widely expected to deliver another 25bps rate hike at its upcoming meeting. Although, in light of recent voting splits (Figure 1.) within the MPC, this will be key to the initial market reaction for GBP. A reminder that last month, BoE’s Cunliffe had been the sole dissenter, voting to keep the Bank rate unchanged. While my base case is for another 8-1 vote split. There is an equal risk of a 7-2 vote with Silvana Tenreyro joining BoE’s Cunliffe as is there with a three-way vote split, in which a rate setter votes for a 50bps hike.

Figure 1. Bank of England Voter Split

Source: Bank of England, DailyFX

With the Bank rate set to hit 1%, the BoE will have some optionality going forward. As outlined in August 2021, the Bank would consider actively selling some stock of purchased assets. Therefore, we can expect the BoE to provide details regarding the outlook and timing of asset sales.

DATA: Inflation has continued to edge higher, the latest reading printing at 7.0% Y/Y (vs Exp. 6.7%) and moving closer to the MPC’s Q2 forecast of 8%. Keep in mind that the data has not included the Ofgem cap increases which is expected to push inflation even higher in the April report. Meanwhile, the labour market remains robust, with the unemployment rate falling to a fresh cycle low of 3.8%. But more importantly, the wages component continued to increase, advocating the case the further tightening in monetary policy remains appropriate.

That being said, last month the MPC altered its rate guidance, stating that some further modest tightening in monetary policy “MAY” be appropriate in the coming months, which is slight softening of guidance from “LIKELY”. This change in guidance is important, given that it highlights the BoE’s growing concern over the cost of living squeeze and its subsequent growth implications, raising the risk that the Bank underwhelms the markets hawkish expectations. (This had been apart of my rationale for my top trade of expecting GBP to drop in Q2) Those growth concerns are likely to increase in light of recent data, where retail sales saw a notable contraction on a monthly basis, while consumer confidence fell to its lowest level since the height of the global financial crisis. To me, this calls for a 25bps move as opposed to a larger rate hike and thus has the potential to weigh on Sterling as money markets price in a 30% probability of a 50bps move. However, as I mentioned above, the vote split will be key.

RATE OUTLOOK: I still believe money markets are far too aggressive about the outlook for BoE policy. This not only sets the bar high for the BoE to be hawkish (relative to expectations) but also leaves the Pound at risk of a dovish repricing.

Money Markets at Risk of Dovish Repricing

Source: Refinitiv

POSITIONING: Heading into the meeting, positioning data via CFTC shows that net short positions in GBP/USD are at the highest since 2019, which does raise the potential of a short-squeeze. Although, this would largely depend on the Federal Reserve outcome and whether Powell meets the hawkish expectations. That said, the sizeable build up in outright shorts, would suggest that bearishness within the currency is well priced in now.

GBP Net Shorts at Highest Level Since 2019

Source: Refinitiv Datastream

MARKET REACTION: Factors that will impact the Pound, the vote split (should the BoE go ahead with a 25bps) and details surrounding asset sales. Of course, the MPC’s view on current market pricing will be closely watched. Heading into this meeting, I sit in the camp of a hawkish disappointment, which I assume is the general view from market participants. However, given elevated short positioning which highlights that the current bearish sentiment is well reflected in the price, this does raise the potential for a short squeeze, which is likely to stem from the FOMC. In terms of levels to watch, topside resistance in GBP/USD is situated at 1.2666, while support is at the YTD low (1.2408). Admittedly, I have not got a strong conviction on GBP/USD with a large focus on the Fed decision, meanwhile, EUR/GBP is likely to maintain its range with the 200DMA capping upside.

May 4, 2022 |  DailyFX
Justin McQueen, Strategist