The Bank of England has a decision to make on Thursday. It is not “to hike or not to hike.” It is to hike by 25 or 50 (obviously, basis points), that’s the question. As well as the rate decision itself, the BoE’s comments on the economic outlook and future tightening, as well as the vote split, will have a big impact on the pound. Barring a big sell-off in risk assets due to the Fed’s policy decision taking place first, on Wednesday, the GBP/USD could be heading to 1.25 if the BoE does not deliver a dovish surprise.
What are analysts expecting?
An already-split Monetary Policy Committee is unlikely to be unanimous as they consider whether to step down a notch or keep going at the 50-basis-point pace. The markets are about 65% confident of a 50-bps hike to 4.0%, owing above all to high underlying inflation, stronger-than-expected wage growth and surprising resilience of the domestic and European economies.
In terms of the votes, it is expected that the MPC will vote 7-2 in favour of a 50-basis point hike. At the December meeting, Swati Dhingra and Silvana Tenreyro voted to keep the Bank Rate unchanged at 3%, while Catherine Mann preferred to increase it by 0.75 percentage points. Will the split widen further? Will more join the dovish camp? If so, this should be bad news for the pound.
BoE likely to revise GDP higher
Insofar as the BoE’s comments on the economy is concerned, it will be interesting to see if the MPC will revise its GDP expectations higher, above all due to lower gas prices. But the focus will be on the Bank’s forecast of inflation. With wage pressures rising, this should keep inflationary pressures elevated, which may mean more rate hikes are needed to be front-loaded in next few meetings.
Cable heading to 1.25?
Will the GBP/USD rise to 1.25 in the event of a 50-bps hike and a somewhat hawkish forward guidance? It may already get there if the Fed, deciding on monetary policy the day before, provides a dovish surprise. If that’s the case, then the BoE’s decision might further fuel the rally.
But given that the exchange rate has already been appreciating, the bigger risk is if the Fed and/or BoE do not conform to market expectations and our base case scenarios. If the Fed is more hawkish or the BoE more dovish and more split than expected, then this could see GBP/USD correct back towards 1.21 and possibly lower.
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