In its quest to fight inflation the Bank of England will welcome onside the recent appreciation in the value of the British Pound.
The Bank of England will on Thursday likely raise interest rates again according to current market expectations in an attempt to stem surging inflation levels which could go as high as 7.0% this year and risk staying above the Bank’s 2.0% target for months to come.
For the Pound the steady build up in expectations for 2022 rate hikes at the Bank has proven a potent source of support: for the UK currency’s valuations to be maintained going forward these expectations must not be disappointed.
Expectations are certainly lofty with Chris Turner, Global Head of Markets and Regional Head of Research for UK & CEE, saying current pricing by money markets “is now at a staggering 1.35% for the December 2022 Bank of England meeting”.
This implies over 100 basis points of hikes are expected to be delivered in 2022, posing questions as to whether the market is getting ahead of itself.
To find out more about how we can assist you with your Second Charge Mortgage please click here
Given the Pound is priced according to these expectations, any paring back of such expectations could result in the Pound retreating from recent highs against the Euro while opening the door to a more concerted downtrend against the Dollar.
But Turner says the Bank won’t want to derail Pound Sterling as a stronger currency in fact helps ease inflationary pressures.
“In the past, in a deflationary environment with weak global demand a former BoE might have issued a verbal rate protest against such pricing – in order to weaken GBP. However, we suspect that the Bank of England is currently welcoming GBP strength in its fight against higher energy prices,” says Turner.
This year has seen the effective exchange rate of the Pound rise to its highest levels since 2016 when it fell in precipitous fashion following the UK’s vote to leave the EU.
The effective exchange rate is a basket of Pound exchange rates that weighs in favour of the country’s main trade partners.
Give the Eurozone is by far the UK’s largest trading partner it stands that the Pound to Euro exchange rate is the effective exchange rate’s largest constituent, and its recent rally to two-year highs has aided the UK’s purchasing power.
A stronger Pound makes the cost of imports cheaper, which is important given the UK is a net importer, thereby acting as a deflationary source.
Turner says a 25 basis point rate hike on Thursday and no protest against market pricing of rate hikes should see EUR/GBP pressing strong support near 0.8275. For those watching the GBP/EUR equation translates into a rise to 1.2084.
ING holds a base case expectation for the Bank to hike rates 25 basis points on a 8-1 vote, raise their inflation forecasts and say medium-term growth has not been impacted by Omicron.
They are expected to signal more “modest” rate hikes are coming but are vague about when they might come.
They are also expected to announce quantitive tightening will begin by not reinvesting maturing bonds purchased under their quantitative easing programme.
A more hawkish scenario – but which does not form ING’s base-case – is the Bank hikes on an unanimous decision and explicitly signals another rate hike in March or May. They also signal a desire to accelerate quantitative tightening via bond sales in coming months.
Here, EUR/GBP goes to 0.8250 (GBP/EUR up to 1.2121).
ING says a dovish outcome would see the Bank of England forgoing a rate hike courtesy of a split decision on the MPC, while signalling that a rate hike is likely at the March meeting.
They would justify going against the market’s expectations for a hike by saying they need more time to gather data regarding the impact of Omicron on the economy.
Here EUR/GBP is forecast to go to 0.8450 (GBP/EUR to 1.1834).
Written by Gary Howes
Source: Pound Sterling Live
Discover our Second Charge Mortgage Broker services.