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BOE Heads Into MPC Rate Decision "Blind"

Stavros Tousios | Wednesday 02 November 2022

Over the past six weeks, the British pound has clawed back around 11% of its value against the greenback. This follows a historic low that was reached on September 26 when GBP/USD fell to a 37-year record low down at 1.0327. The former government had released its "mini-budget'' details on the 23rd, following the BOE's last policy meeting on the 22nd. The drop in the pound naturally impacted UK stocks and the UK 100 index as investors might have started to lose confidence in the new government. According to some market watchers, the BoE might have had to step in to prevent a possible market crisis, which also precipitated the election of a new Prime Minister, namely Rishi Sunak.

Bank of England Rate Decision

Questions around how the UK government would finance budget cuts led to a spike in long-term guilt interest rates. The immediate worry was that it could lead to a spiraling effect as pension funds would have been forced to sell their holdings. But it also showed that liquidity in the UK gilt market was under pressure, contributing to a broader reevaluation of the county's finances and global financial markets. (Source:The Guardian)

BoE Decides without Details of Government’s Plans

According to Bailey, the BoE is gathering again “blind”, without knowing much about what to expect from the new government. The new budget planned for release on October 31 has been delayed to November 17 as the government tries to figure out how to plug what is reported to be a £40B hole in its finances. Media outlets are already talking about tax increases and spending cuts. Moreover, the BoE's governor Andrew Bailey had approved of the sequencing of the new Chancellor. Jeremy Hunt, for promising to provide an update on the UK government's plans ahead of the monetary policy meeting as "the right sequence". 

The policy leading to the sudden drop in the pound has been scrapped at this point and the new economic policy expected later in the month has been upgraded to a full Autumn Budget, including OBR’s forecasts. In the meantime, markets seem to have calmed down and may have given the BoE confidence to carry through with their planned quantitative tightening earlier this week. The operation went off without a hitch when the BoE offered three-quarters of a billion pounds in short-term debt with a surplus of buyers. There were more buyers than for UK Treasury bond sales, but the amount offered was not as large. The implication is that the bond market probably has sufficient liquidity to handle both the UK government and the BOE selling gilts.

Next BoE Meeting: What to Expect?

There seems to be a solid consensus that the BoE might raise rates by 75 basis points, the most significant hike in over 30 years. But, the expectation is that this is likely to be tempered with more dovish guidance, suggesting that a hike of this magnitude might be a one-off deal. 

Inflation hit a 10.1% high back in September, but on Monday, the Office of National Statistics said that the energy plan might help to reduce it. Furthermore, it should be noted that the energy plan of the former Chancellor was largely left intact by the new government and didn't receive the same criticism as other proposals. The BoE is facing high inflation, but the possible recession and measures could lead to inflation dropping in the future. (Source:CNBC)

Demystifying the Vote Count and Why the Split Matters

At the last BoE meeting on September 22nd, the split of votes was essential to the market reaction. There was a three-way vote split, but the majority voted for a 50bps hike. Dissenters mostly wanted more aggressive action (those being Ramsden, Haskel, and Mann). Only Shingra voted for a 25bps hike.

The last time the BoE had a 5-4 vote split, which implies uncertainty about the bank's direction, was in 2007. So, the more members vote for 75bps; the more hawkish the BoE is expected to be. 

The Bottom Line for Traders

The consensus that the BoE will hike aggressively but temper expectations for future rate hikes supports the pound as its main trading partners (Fed and ECB) are raising at a similar rate. The takeaway from the meeting could focus on the vote split to see how much appetite there is for another hefty hike at the December meeting. Traders will have to be a little more patient for the event to end to see how the MPC members have voted.

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