Pound to struggle even if BoE goes for hawkish rate hike

[MongiIG]

This week’s BoE meeting could be crucial for the current bounce in GBP/USD, should be bank be more cautious about the outlook for the UK economy

Source: Bloomberg

 

 Chris Beauchamp | Chief Market Analyst, London | Publication date: Wednesday 02 November 2022 

This week sees the Bank of England (BoE) meet once again, and markets expect a 75bps rate hike, taking interest rates to 3%, another post-financial crisis high.

What will the bank do?

Markets are generally united in expecting a 75bps increase in rates. Inflation hit an annual rate of 10.1% in September, around five times the 2% target rate set by Threadneedle Street. This argues for another sharp rise in rates, and more to follow.

Markets still expect the interest rate to peak around 5% in 2023, before the bank heads towards a series of rate cuts to stimulate the economy. But a UK recession seems inevitable at this point, and the bank itself expects it to last around five quarters. To continue tightening into such an event would seem like the height of folly.

What comes next?

Instead, this time around could see just a 50bps rise, and perhaps another 25bps rise before the end of the year. High mortgage rates, the end of the political ‘crisis’ of September and October and reduced inflation expectations could mean a shift away from such hawkish policy.

This might be indicated by a strengthened dovish caucus on the Monetary Policy Committee (MPC); while all the nine members voted for a rate increase in September, and three wanted to raise by 75bps and not 50bps, only one member wanted a 25bps rise. But with the economy slowing, or likely to slow, we could see more members this time around vote for a smaller increase.

A lot will be driven by the forecasts for the year ahead. Indeed, a downgrading of already weak growth outlooks would give the doves on the MPC a reason to be more forceful.

What will be the impact on sterling?

While much (if not everything) in GBP/USD depends on what the Fed does the day before the meeting, a more dovish/cautious BoE would likely put further pressure on sterling.

Indeed, the rally from the September lows perhaps increases the likelihood of a revival of the downtrend. Now more optimistic forecasts for the UK economy and a hawkish Bank of England are priced in (or to look at it the other way, a more dovish Fed has been priced in). Should the MPC be more cautious, then we should expect further weakness in the pound, building on the small retreat from $1.16 we have already seen.

This would then test trendline support from the September low, and signal that a fresh leg to the downside has begun. A surprise-hawkish BoE provides more energy for the current counter-trend bounce, and might result in a move back towards the $1.17 area.

Source: ProRealTime