The GBP/USD was about 0.4% lower on Thursday morning ahead of a Bank of England monetary policy decision considered to be the most unpredictable in years. Investors may be nervous as the U.K. central bank heads for an interest rate decision on a knife edge.
The pound sterling dropped below 1.35 versus the U.S. dollar on September 29th. This level was Cable’s lowest since 2020, on stagflation concerns, on the heels of the global supply chain crisis. Stagflation is made up of two words: “stagnant” and “inflation”. It is the economic term for what market observers consider as the worst of all worlds, a perfect storm of adverse developments. Stagflation conditions include high unemployment in a time of slow economic expansion, in addition to high inflation. Inflation in England climbed to 3.2% in August from 2% in July in the sharpest jump in the country’s recorded history. Britain’s consumer price index (CPI) for August rose to its highest since March 2012.
Nevertheless, one day later, on September 30th, the pound rebounded by almost 0.4% compared to the American dollar. That was the start of a five-day rally, during which the GBP/USD advanced 1.5%. This gain was the longest winning streak since the rally that ended February 24th, which added 2% in value to the pair. That turnaround came after data showed that the U.K. economy grew at a much faster rate than anticipated in the second quarter, which bolstered the chances of an interest rate hike.
Cable kept climbing till a peak on October 20th at 1.3799, a 3% rise since the September 29th bottom. Since then, the currency pair’s trading price has retreated from the October 20th peak to a rate of 1.3636 as of the time of writing, a 1.4% loss. Supply and demand first bid the U.K. currency to its October 20th high, before it backtracked some of its way back down to the September 29th nadir. It is noteworthy that as of the time of writing, the price is just about where it was at the top of the five-straight-day rally.
So, why is trading running the pair up and then down some before today’s interest rate decision? Naturally, no one knows, but perhaps the market is attempting to find the right balance for the price that projects the BOE’s decision’s uncertainty. Monetary Policy Committee (MPC) members are seen to be unsure as to how to vote on interest rates because of a lack of clarity regarding the British job market. Policymakers haven’t seen an Office National Statistics survey that reflects the job situation for about 1 million workers formerly on furlough after the program ended.
However, economists think the BOE could be the first major central bank to hike rates after the pandemic, one day after the Federal Reserve reiterated that it might not do so in a while. Meanwhile, analysts are split about the chances of a rate hike on Thursday at noon GMT. Derivative traders estimate a 64% chance of a 15 basis point rate hike in this meeting.
Three Possibilities for Pound Reaction to Today’s BOE Meeting
HSBC (HSBA-L) breaks down pound traders’ reaction to three possibilities:
The BOE will decide on a 15 bps hike, “affirming” the market’s expectations of another 85 basis point increase by the middle of next year. This decision would be the most hawkish so far, prompting the most bullish response for the GBP/USD.
Policymakers will raise 15 bps but will not expect any further hikes till 2024. This decision will be a middle-of-the way, perhaps adding only some bullishness to the Cable.
A third possibility is no rate hike and a pushback on market pricing of future rate hikes until 2024. HSBC forecasts that such a combined dovish result will provoke a pound selloff.
How is the UK100 Faring Ahead of the BOE Meeting?
The UK 100 (UK100) was flat Thursday morning ahead of the MPC meeting. The leading U.K. stock index has had quite the opposite reaction to that of the country’s currency regarding the economic news mentioned above. On September 29th, when the pound fell due to the risk of stagflation, the UK 100 rose 1.10%. On the other hand, the following day, when the pound rebounded, the British benchmark declined by about 0.03%. The equity gauge fell under pressure from a firmer pound on September 30th after investors shrugged off the risk that inflation could pose on the price of stocks the day earlier when a weaker pound could boost exports. Still, since September 29th and till Thursday, the British gauge climbed 3.35%.
How might the BOE interest rate decision affect the GBP and UK 100? Will the two distinct asset classes repeat their divergent pattern, as they did on September 29th and 30th, or will they move in tandem, as they broadly have since?