GBP/USD has everything to lose from the BoE
|A 25 bps hike looks in the bag
A 25 bps interest rate hike from the Bank of England (BoE) looks almost certain on Thursday. The big question is how will the pound react to a second consecutive hike following 15 bps in December. Given so much is already priced in terms of expectations for Thursday's meeting, GBP/USD has more to lose than gain.
By most measures the BoE is justified to raise rates by 25 bps when it meets. UK economic activity has now returned to pre-pandemic levels. UK CPI inflation rose by a more than expected 5.4% as the unemployment has fallen from a peak of 5.2% in December to a low 4.1% in November.
Omicron didn't stop the BoE in December
Meanwhile, the UK economy has held up relatively well despite Omicron related measures to tame the spread of the virus. Then again, Omicron didn't stop the BoE raising rates in December. One could even go far enough to say the BoE is willing to overlook all but the worst in terms of COVID-19.
In fact, Thursday's anticipated hike plays a bit of catch up from November, when the BoE surprised by leaving interest rates on hold. Some speculate that the BoE was just holding out on post furlough scheme employment data before raising interest rates.
Expectations beyond February look flush
On that basis a February hike looks largely in the bag. That said, traders may have taken things too far in terms of interest rate expectations further down the line. At the time of writing, interest rates markets were pricing the BoE tightening by 1.25% by the end of 2022.
Therefore, Thursday's outcome will come down to fine details. Firstly, will the vote split be 8-1 as in December? Secondly, will the the BoE England do as it promised and stop reinvestment of its asset purchases when the bank rate hits 0.50%? Finally, what will be the new BoE projections be in terms of inflation?
Three key questions will move markets
On all three questions, none is likely to be enough to move interest rate markets to price in more hikes. Every chance exists that the vote split remains the same, or at worst moves from a strong majority to unanimous. In terms of ending reinvestment, that has already been well signposted. In addition, the BoE projections on inflation will be tempered as the Bank of England uses market implied rates.
Furthermore, there is every chance that the BoE statement tries to balance a tight rope in terms of tightening policy in the near term without boxing themselves into a single policy direction. That ultimately could lead to near-term yield lower and the GBP/USD. GBP/USD has recently been closely correlated with UK and US 2 year yield spreads.
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