The BOE will be meeting on Thursday in a fraught environment that could lead to some shake ups in the market. The UK economy is teetering on recession, which makes it difficult for the central bank to fight inflation. Consumer prices have been rising at over five times the target rate.
The extraordinary circumstances have led to a growing rift within the BOE on how to deal with the situation. That split is likely to be the main focus among traders in the aftermath of the meeting. The tally of votes can be determinant about where the market expects policy, and therefore the pound, to go over the coming weeks.
Two roads diverged in a yellow wood
There are basically two paths ahead for the BOE, and so there is a lot of focus on which one is most likely to be chosen. The one that is for now most expected, since it has the most votes in the latest meetings, is to keep tightening policy. The downside is that it could make the current recessionary situation even worse. For traders, that would imply a strengthening pound, at least in the near term. It could see the BOE hiking by 50bps or more in the coming meetings.
The minority position is in favor of rescuing the economy in the near term, arguing that inflation is due to factors beyond monetary policy. This has led to two votes for not hiking rates in the last couple of meetings. Out of the nine members, it’s still a very minority position. But, if more members were to switch towards this camp, it could substantially weaken the pound.
… and I chose neither
There is a potential third option, in which the BOE doesn’t take either path, and ends up in the worst of both worlds. Last year, the bank started raising rates first, giving the impression it was the more hawkish of the central banks. But it then stubbornly kept raising rates slowly, and was quickly left behind by the Fed.
Now it’s in a place with relatively high interest rates threatening a recession; but also high inflation, with the need to keep raising rates. Unlike in the US where the more aggressive action by the Fed is seen as contributing to cutting inflation faster. On the other hand, the UK is unlikely to avoid a recession like Continental Europe, where lower rates have not restricted the economy so much.
Where the consensus lies
The BOE has raised rates 10 times so far, and is expected to do so again. The consensus is for another 50bps hike, bringing the rate to 4.0%. Money markets are pricing in a peak rate of 4.5%, which means that the BOE could “top out” in March.
Meanwhile, money markets are also pricing in the first rate cut in the UK for the end of the year, as the recession is expected to get worse. A worsening recession would be expected to lower inflation as monetary circulation slows, then the BOE could cut rates. Given the growing consensus that the economy will underperform this year, BOE hikes could have a dwindling effect on the pound. That’s because traders are increasingly expecting those hikes to be reversed in the near future.
