Tue, Dec 06, 2022 @ 05:17 GMT

Bank of England Preview

The Bank of England’s policy decision on Thursday will come hot on the heels of the FOMC meeting the day before, which should mean lots of volatility for the GBP/USD pair. The cable has been able to climbs sharply off its all-time lows in recent weeks, while the EUR/GBP and other pound crosses have also stabilised, thanks to the somewhat positive political situation in the UK and calmer tone across the financial markets in general. But will the BoE’s rate decision trigger a renewed slide in the pound?

Calmer political situation

The appointment of Rishi Sunak as the new UK PM following a disastrous 45 days during Liz Truss’s premiership has helped to calm investors nerves a little here, with both the pound and UK bond prices stabilising somewhat. While uncertainty remains, the focus for the traders is slowly shifting away from politics and towards more macro themes affecting the wider financial markets.

The Bank of England faces another tough decision this week as it prepares to push interest rates even higher, in order to help bring inflation under some control after CPI raced to above 10% in September on an annual basis. Analysts are expecting the BoE to hike by 75 basis points at this meeting, but it is clear that the policymakers at the Bank are not comfortable about the level of tightening the market has priced, with rates seen peaking just below 5% in 2023. A 75-bps hike on Thursday would lift rates from 2.25% to 3.00%, which would be the highest since those dark days of the global financial crisis.

How will the pound react to BoE rate decision?

It is not just the rate decision itself that will move the pound on Thursday.

The vote split, the BoE’s language, as well as growth and inflation forecasts, will all have a say in how the currency will react. Generally, the more hawkish the BoE is compared to expectations, the more upside should be expected in the immediate response. The opposite is also true. For example, if the BoE says that the committee feels several forceful rate increases are warranted to bring inflation down, this will be quite hawkish. In contrast, if the BoE signals greater worry over economic growth than inflation, then this will imply a reduction in future rate hikes and a lower terminal rate, and thus lead to a negative response in the pound.

What that in mind, if the BoE decides to validate market expectations and hike by 75 basis points, then this could send the pound higher, driving the EUR/GBP to 0.85 handle. The Chunnel could fall even lower if the BoE does not make it clear that this will be a one off 75 bps hike.

A dovish surprise of a 50-bps hike, on the other hand, could initially lead to a drop in the pound, but if this is accompanied with a stronger hawkish message in terms of future hikes then we could see a quick rebound.  Still, this potential decision could see the EUR/GBP rise to 0.8800, before deciding on its next move.

As mentioned, it is not just the rate decision that is important, but the central message about the path of interest rates.

Why the BoE might not deliver hawkish surprise

There are a few reasons why the BoE might opt for a smaller hike at this meeting or provide a less hawkish signal about the future decisions. The weaker PMI and growth figures we have seen of late are, by definition, disinflationary. What’s more, the government’s U-turn on tax cuts means there will be less of a fiscal boost than before. The fiscal risks are now less of a concern than before and the BoE would want to wait and see what the government offers in the delayed budged, than send out the wrong signals. Furthermore, the rebounding GBP/USD has reduced concerns about more inflation being imported.

Clearly, the BoE will not want to overreact and then have to quicky undo the hikes when inflation and economic output both falls.  Against this backdrop, I reckon the chances for a hawkish surprise are slim, even if inflation is above 10% now.

EUR/GBP in focus ahead of BoE rate decision

With the FOMC rate decision taking place a day before the BoE, it might be a better idea for us to concentrate on the EUR/GBP than the GBP/USD, to see the pound’s less-diluted reaction to the BoE decision. The EUR/GBP is now not too far off testing key support and the 200-day average around the 0.85 handle. It will likely get there if the BoE opts for 75bps, but as mentioned above, the pound could then weaken again depending on the BoE’s use of language etc. Key short-term resistance is seen around 0.8720 – a potential break above this level could trigger a fresh wave of technical buying towards 0.90s in the days and weeks to come.

Forex.com
Forex.com
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