The Bank of England are tipped to raise interest rates and deliver guidance on future policy on Thursday, November 2. Here are the likely scenarios that will play out for the Pound.
The Monetary Policy Committee - that is the board within the Bank of England tasked with deciding whether to raise or lower interest rates - are likely to raise them by a quarter of a percent, in order to combat rising inflation and provide further support to Sterling.
Higher interest rates encourage saving by increasing the incentives to put money in the bank and disincentivise borrowing by making it more expensive.
What has this got to do with Sterling?
Higher interest rates don't just act as an incentive for people to save in the UK but also for foreign investors to transfer their money to UK banks where it will earn more interest.
This increasing flow of inbound money raises demand for Pounds and thereby strengthens Sterling.
Therefore, assuming the MPC does what everyone expects on Thursday, the Pound will rise - right?
Well maybe. A lot depends on what the BoE is planning for the future - ie their outlook: are they planning more hikes, or is it a question of 'one and done'?
"What could really drive GBP higher is if the Bank signals that this is more than just a 'one-and-done' move and instead the start of a gradual tightening cycle. Gradual is a pretty fluid concept – and while the next rate hike will inevitably be data-dependent, this laissez-faire forward guidance won't stop markets from bringing forward their expectations for additional BoE rate hikes," says Viraj Patel, analyst with ING Bank N.V.
The MPC take a vote to decide what to do with rates and the result is published with the decision; the degree of the move in Sterling, therefore, may well depend on the outcome of the vote, for example, was it unilateral, or were there dissenters, and if so how many?
Another factor is the content of the discussions recorded in the meeting minutes; do they indicate an inclination to expecting more interest rate hikes or was there much fierce debate suggesting a rift and a lack of consensus, and therefore, less chance of further hikes?
Finally, because it is a 'Super Thursday' there will also be the quarterly inflation report to peruse and a press conference with BOE governor Carney, this should also speak volumes as to future policy - a nudge up in inflation forecasts would certainly suggest the potential for future interest rate rises remains vailid.
Watch Governor Mark Carney's press conference following the release of the decisions and forecasts - what he has to say might provide further clues which could illuminate the outlook and impact of the Pound.
A Cheat-Sheet for Those Watching the Pound
Canadian Investment Bank TD Securities have drawn up an illuminating guide to Thursday's BOE meeting for investors suggesting different scenarios and how these could impact on Sterling.
In accordance with the consensus, TD believe the Bank will raise interest rates by 0.25% but in addition, their base-line scenario also foresees the exact disposition of the voting, which they expect to be split 7-2 in favour of raising rates.
TD Securities apportion a 75% probability of the BoE meeting matching their baseline scenario, but what then do they forecast happening to Sterling?
Well strange as it seems, they actually expect Sterling to fall on the news.
This is simply because the expectation that the BoE will raise rates is now so well broadcast that the market may already have adjusted.
Put another way people are now so certain the BoE will increase rates on Thursday that the Pound has already run higher - purely from investors buying before the fact based on that certainty.
This why in their most probable outcome TD Securities forecast Sterling to actually weaken versus the Euro, with EUR/GBP rising to 0.8850 (from the current market level of 0.8801). This gives a fall in the Pound-to-Euro exchange rate to 1.13 from current levels of 1.1350.
For such an outcome, the MPC must also "strike a somewhat cautious tone as the hike is driven by weaker supply growth, middling demand growth, and strong inflation."
They expect the exchange rate to fall to 1.3165, from the current level of 1.3298.
Above: Scenarios for Euro-Sterling
With a 15% probability outcome, their second most likely scenario is a 'hawkish' hike, which means the MPC vote to raise rates with more unanimity, that is with an 8-1 or higher vote.
The MPC would also be seen to be "united around a hike, and strike a positive tone highlighting growth above their forecasts and a healthy labour market, while expressing some concern over high inglation."
This outcome would, at current levels, lead to a rise in the Pound.
EUR/GBP would fall to 0.8685 (GBP/EUR at 1.1514) and GBP/USD to 1.3415.
Of this scenario, TD says the following:
"The MPC sets the stage for a second hike in the next 6 months by saying that a majority expects rates to continue rising in the “coming months”while reiterating that the yield curve is too flat."
Finally, with only a 10% probability of happening, the third scenario modeled by TD Securities is for the BoE not to hike rates whatsoever and maintain the view that a rate rise is likely in the near future.
This would lead to Sterling falling precipitously and EUR/GBP rising to 0.8925 EUR/GBP (GBP/EUR down to 1.12) and 1.3050 GBP/USD.
In such a scenario the decision not to hike is probably likely to be a 'delay' with the "majority expecting a rise in coming months".
In such a scenario inflation would also remain unrevised in the quarterly inflation report, at least in years 2 and 3.
Above: Scenarios for Sterling-Dollar
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