British Pound Leaps Higher on Bank of England Event: Preview, Scenarios and Reactions of Sterling vs Euro and US Dollar

  • Sterling Quotes:
  • Pound-to-Euro exchange rate today: 1 GBP = 1.1183 EUR
  • Pound-to-Dollar exchange rate today: 1 GBP = 1.3298 USD

 Bank of England, City of London

The British Pound has risen against most major currencies as the Bank of England warns the market is underpricing expectations for future interest rate rises.

The rise comes despite the 7-2 breakdown in the composition of the vote to keep interest rates unchanged.

Markets were looking for a 6-3 breakdown as a signal that the Bank was leaning towards raising rates.

This is in itself therefore a GBP-negative outcome.

But in the accompanying minutes, the Bank warned that the market was complacent regarding the speed at which future interest rate rises would need to be delivered.

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The Preview: We Warned the Bank was not Happy with Market Complacency

How will Pound Sterling react to the Monetary Policy Committee’s latest policy update, due mid-day London-time at the Bank of England?

Ahead of the event we are seeing traders show their nerves and cutting back on exposure to the UK currency; Sterling is lower against the mjority of the G10.

Policy events are incredibly difficult to anticipate, with the eventual move in Sterling dependent on various nuanced messages about the economy, financial conditions and expectations.

But, we are able to identify the various triggers that will likely move Sterling.

Note the Pound shot higher on Tuesday. It then reversed some gains on Wednesday. This leaves the Pound nicely balanced for a move either way on the Bank of England event - had Tuesday’s gains not reversed somewhat, we would be concerned of a deeper correction on any disappointments today.

The Bank is widely expected to leave interest rates unchanged but with other central banks in the process or preparing to reduce stimulus, traders are looking for any hint that the Bank might reverse the 0.25% interest rate cut delivered in 2016.

Why this Meeting Matters

At the August policy event, the Bank’s MPC voted 6-2 to leave rates unchanged, cut their forecasts for GDP and wage growth and expressed concerns about the economic implications of Brexit.

Since then we've seen inflation leap towards 3.0% and average weekly earnings growth accelerate from 1.8% to 2.1%.

“These positive developments are encouraging,” says Kathy Lien, Director at BK Asset Management who also cautions that there remain pockets of concern elsewhere in the economy.

Of note, service sector activity slowed last month and most importantly, consumer spending took a hit from the prior slowdown in wage growth.

The Bank Might Want Higher Rates, and a Stronger Pound

While the Bank of England is widely expected to keep policy unchanged on Thursday, there is reason to believe the Bank wants both higher interest rates and a stronger Pound.

"We look for two signals that could mark a positive turning point in GBP sentiment and end the 'Great British Sell-off' in currency markets," says Viraj Patel, an analyst with ING Bank N.V. based in London.

1) Market pricing suggests that there is a barely 1 in 4 chance of a 25bp Bank rate increase this year, which rises to only a 65% probability by the end of 2018. ING believe the markets are too complacent with regards to the number of interest rates coming down the road.

Market expectations future interest rate rises

Above: (C) ING Bank N.V.

This is problematic as when the Bank does start raising rates, the markets might be prone to a sudden, destabilising adjustment.

The Bank will want to prime markets accordingly, and this should send Sterling higher.

2) On this note, ING believe the Bank will want a stronger Pound.

The Pound's recent decline takes it "into a territory that may require greater attention from policymakers," says Patel.

While the trade-weighted index has rebounded sharply to above 75 over the past week, ING acknowledge that were it to stay at these depressed levels it will result in an upgrade to the BoE's inflation projections at the next forecast round in November.

Trade weighted exchange rate pound sterling

Above:The Pound's effective - or trade-weighted - exchange rate is off recent lows. This is an overall gauge of Sterling value, based on a basket of key Sterling-based exchange rates. Members of the basket are weighted according to the importance of a country or region in terms of trade to the UK.

"We wouldn't be surprised to hear greater BoE noise over Sterling weakness at this week's meeting, primarily in terms of what this means for inflation overshooting the 2% target and whether the growth-inflation policy trade-off has altered for some MPC members," says Patel.

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The Upside Triggers for Sterling

There are a number of outcomes that could signal a rally in Sterling.

“The BoE is an inflation focused central bank which means it will be difficult for policymakers to ignore the rapid acceleration in price growth. They may try to downplay the increase but they could also suggest that the yield curve is too flat, implying that the market is underpricing the chance of tightening,” says Lien.

For this reason BK Asset Management expect a more hawkish BoE statement that will lead to an increase in interest rate expectations and the British Pound.

Lien says if the BoE votes 7-2 to leave interest rates unchanged and send a hawkish signal to the market, GBP will rise.

If the Bank’s Chief Economist Andy Haldane who previously suggested tightening could be necessary joins the ‘hawks’ and votes for a rise, taking the vote at 6-3, “GBP/USD will break 1.33 quickly and aggressively,” says Lien.

We have identified Haldane as being a key trigger to direction in Sterling in our recent reporting, here.

On such an outcome, we would expect the Pound-to-Euro exchange rate break above the key 1.11 level and eye a move on 1.12. Of note, analysts at ING Bank reckon a sustained move above this level would effectively "shelve" expectations for a broader fall to parity in the exchange rate.

The Downside Triggers for Sterling

If the MPC say they will look past the temporary rise in inflation and emphasise the uncertainties ahead along with the risks to growth, the Pound would likely suffer.

Furthermore, a 7-2 vote split might be equally as disappointing.

"The prospect of a surprise shift in voting intentions today’s meeting likely rests with Andy Haldane who, in June, hinted at potentially supporting some degree of policy tightening before the end of the year. Given the mixed news on the economy over the past month, we doubt that he will be sufficiently persuaded to vote for a hike at this meeting," says Nikesh Sawjani at Lloyds Bank Commercial Banking.

Pound Sterling will likely succumb to selling pressures and the currency will fall back towards the subdued levels we have become accustomed to over recent months.

We doubt there would be a major rout of the Pound owing to the substantial negativity that already exists; particularly versus the Euro.

It will take significantly negative news - most likely on the Brexit front - to really drive fresh negativity.

"We do not rule out a move to parity if politicians fail to allay fears that a cliff-edge is looming," says Jane Foley at Rabobank.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.
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