BoE lag suggests rough road for Pound

BoE lag suggests rough road for Pound

In a week where the Federal Reserve raised US rates for the first time in 3 years and the Bank of Japan raised their base rate to its highest since 1995, all whilst the Bank of England sat on its hands. This was not surprise, with futures positioning suggesting the market only priced in an 8% of a hike this Thursday, surprising on the face of it, given that energy prices are already triggering rises in UK CPI and shows no signs of fading away.

But as a heuristic, the BoE leans against raising rates unless absolutely necessary, even as the Fed was given a fait accompli by the Treasury market to raise rates on pain of sky high yields, the BoE simply pushed through. The Bank of Japan, under heavy pressure from the US Treasury, raised their rates despite disunity amongst voting members that has since undermined the Yen, whilst the BoE registered the same 6-3 hold over hike vote share as the last meeting.

Yet despite this reluctance from Monetary Policy Committee members to show much aggression in the face of inflation possibly topping 4% next year (by their own estimates), the market still prices in a near 5% interest rate this time next year.

I view this as unlikely for a multitude of reasons, the first of which is that it assumes there will be no change to the prosecution of the war anytime soon. Trump is already making a play for negotiations today by threatening fresh strikes on Iran unless they “make a deal”. Moreover, the onrushing mid-terms and a potential Dem sweep of both houses of Congress threatens Trump’s ability to fund the war, assuming he does nothing to wind it down ahead of the vote.

Secondly, Governor Bailey has on several occasions expressed some level of regret in the banks response to the Ukraine energy price spike, ruminating that raising interest rates is not the most effective way to deal with a supply side issue. Of course, the Bank has little other options to combat inflation and its decision to cease selling long dated Gilts as part of its QT effort somewhat ensures that higher yields will not have the disinflationary impact they may have had.

Still, the BoE is the obvious stick in the mud this week, giving a vague suggestion of “hikes to come” but offering little practically. There will soon be a reckoning where this becomes more obvious in markets and the Pound will be the number one victim, but as the saying goes, you would be surprised for how long the market can be wrong.