Is the Bank of England trapped?

Sonia futures say, ‘yes’. The current expectations of GBP future markets are that the Bank of England will hike rates four times next year. That seems very steep.

Now, perhaps tellingly, the GBP has not surged higher on these Sonia IMM future pricing. The focus is now on what the Bank of England does on Thursday.

The wider question on inflation

The key point is this: ‘How effective will hiking interest rates be in controlling inflation?’. The Bank of England’s response will be an answer to this. If the Bank of England pushes back against the Sonia futures rate hike pricing then expect the GBP to correct lower quite sharply. They will in effect be saying that inflation is still, to some extent, transitory. The flattening of yield curves has markets concerned that a too-fast hiking cycle only hinders growth in the long run. This makes sense as inflation is being driven by higher energy prices, supply chain restraints, and commodity price rises. Some of these should fade as we exit more restrictions.

So, transitory inflation may be closer to 18 months than 6 months, but hiking too quickly will only crush businesses starting to get going again.

The trade

Labour data remains important to the Bank of England, so they may decide to postpone hiking rates on Thursday deciding to wait for more jobs data post the end of the furlough scheme. The key risk for the GBP will be the following communication:

• No rate hikes (or a ‘one and done’ scenario).

• Pushing back against market pricing.

Expect some GBP downside.

On the other hand, if the Bank of England does:

• Hike by more than 15 bps.

• Accept market pricing.

• End QE.

• Revise hiking projections higher.

Then expect EURGBP selling.

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