The Bank of England Preview: Dovish rate hike set to undermine Sterling's ground

• The Bank of England is expected to deliver the one and only rate hike in 2018 while deciding on monetary policy and publishing the Inflation Report on Thursday, August 2.
• While Brexit uncertainty is still present, the Bank of England will make sure everyone understands that this was the final rate hike this year and for long as it marches the gradual and limited path of policy normalization. 
• Delivering dovish rate hike is set to undermine Sterling’s ground on the currency market. 

While it is widely expected that the Bank of England will hike the Bank rate from 0.50% to 0.75% at its tomorrow’s meeting, the voting pattern is set to remain split and the uncertainties will prevail in the decision making of the Monetary Policy Committee (MPC) so the Sterling is likely to suffer following the decision. 

Markets are all convinced of the Bank of England delivering tomorrow with the probability close to 90%. And the Bank of England will lift the Bank rate to the highest level in a decade. That’s about the most important historical. Otherwise, the language around the rate hike is set to remain dovish with an accent on “gradual and limited” path of the Bank rate normalization.

As the August MPC meeting is the final one for Ian McCafferty, who will be replaced by slightly more dovish successor Jonathan Haskel, the mission will finally be accomplished for the old school hawk who is together with Michael Saunders voting in favor of a rate hike since March this year. In June, the Bank of England chief economist Andrew Haldane unexpectedly joined the camp of hawks, so the convincing majority at the MPC will need only Governor Mark Carney, Deputy Governor Ben Broadbent, and the external MPC member Gertjan Vlieghe to vote 6-3 in favor of a rate hike. 

While I Other Deputy Governors Jon Cunliffe and sir David Ramsden are seen as arch-doves the open question is about the voting pattern of another external MPC member Silvana Tenreyro. 

So the Bank of England is set to hike the Bank rate in August, but it will deliver a dovish outlook for the future making sure that everyone understands that this was the final rate hike this year. And this is the reason why the markets might be surprised to see Sterling falling even after the Bank of England rate hike. 

Fundamentally, there are strong reasons for the Bank of England to remain conservative as far as concerning the monetary policy outlook. Especially the combination of wage growth and inflation is not particularly convincing.

While the unemployment rate remains stuck to a four-decade low of 4.2% and the employment rate representing the proportion of people aged from 16 to 64 years who were in work rose to  75.7% in June, the highest since comparable records began in 1971, the wage growth decelerated.

Compared with the May Inflation Report, the UK wages decelerated from 2.9% y/y to 2.7% y/y after excluding bonuses while wages including bonused decelerated to 2.5% y/y.

The UK inflation is still above the policy target, but the core inflation decelerated in June. With wages likely to be a less of the inflation stimulus and the post-Brexit Sterling’s depreciation fully absorbed in past inflation, the decisive argument supporting the rate hike is the economic growth returning to trend after a soft start of the year.

As the Brexit uncertainties still dominate the background of the economic development and are likely to remain the source of the uncertainty for the rest of this year, the Bank of England will repeatedly emphasize the graduality and limited path of its monetary policy normalization.

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