Pound takes 'a couple of legs lower', BoE 'held hostage by geopolitics'

GBP/USD has taken a couple of legs lower this week, first following the hawkish Fed announcement on Wednesday and then again after yesterday’s Bank of England rate decision.

The BoE’s rhetoric was actually rather hawkish on Thursday, as while it said that there was so far “little evidence” of second round inflation effects, the risks are clearly building and the bank acknowledge that hikes may be needed should the energy situation not be resolved soon.

Indeed, several members who backed a hold this month explicitly flagged that they could soon pivot in favour of a hike should the energy shock persist - a clear signal that higher rates may be in the offing fairly soon.

The sell in the pound is, therefore, somewhat surprising and we think probably has more to do with the lack of additional dissenters, an absence of a firmer hint at a November hike and a classic “buy the rumour, sell the fact” response among currency traders, who clearly had higher hopes than us for a hawkish surprise.

We remain sceptical whether higher rates are actually warranted in Britain. The domestic outlook would suggest not: wage growth is slowing, employment is weakening, core inflation is stable and second round effects appear unlikely to materialise.

But the MPC seems to be being held hostage by geopolitics, and clearly there are concerns in the committee that if they don’t act soon, higher energy prices could begin filtering into the broader economy.

A precautionary hike in either November or December is, therefore, not out of the question - though we expect any tightening to stay true to that label: insurance-driven and modest in scale.