Expectations for what the BOE will do when it meets tomorrow have been shifting quite a bit recently. Just last week, a poll of economists by Reuters showed a near universal agreement that the BOE would hike by 25bps. That was in the wake of the ECB’s decision to go through with its 50bps hike, and the Fed was still expected to hike as well.
Since then, Credit Suisse was forced to be bought out by UBS, and markets have not been reassured by the actions taken by regulators to prop up stressed banks. Despite the Fed setting up liquidity support for banks in the US, First Republic shares have struggled to recover. Regulators in Europe insist that their banks are under a completely different framework, but the collapse of Credit Suisse – a much bigger bank than any of the banks that have failed in the US, even during the financial Crisis of 2008 – has shaken confidence in Europe’s financial isolation.
Risks keep mounting
So far, UK banks have appeared to be in good shape relative to the other two major economies. The UK went through its own version of an interest-rate induced liquidity snap last year, which forced the BOE to initiate a QE for a brief period even as it continued to hike rates. UK banks had their “warning shot”, and the separation of monetary policy from regulatory support of the banks seemed to work well. For this reason, the BOE might simply go through with the rate hike, like the ECB did to reassure markets.
However, over the weekend there was a coordinated boost by all the major central banks to increase liquidity available for banks. Given all the announcements surrounding Credit Suisse and UBS, it might have gone a bit under the radar. It could be understood that central banks are worried about bank capitalization and access to liquidity, and that could drive a pause in hiking. Since higher interest rates result in less liquidity.
Bringing the pieces together
Therefore, the pivotal elements for the BOE’s decision could be known later today, particularly whether the Fed goes through with its own hike. There used to be strong expectations that the Fed would hike, but that has fallen substantially. Markets are now pricing in a 50-50 chance that the BOE will hike at the next meeting.
Where there does seem to be substantial agreement is what will happen after this meeting, with both economists and the markets expecting no further rate hikes for the rest of the year. In fact, one rate cut is expected near the end of the year.
To recession, or not to recession?
However, those expectations were calculated before the release of the Spring Budget, in which Chancellor Hunt announced a £200B increase in spending and tax cuts. Subsequently, the risk of a recession was downgraded, and with that the chance that the BOE will cut. On the other hand, inflation might remain higher than expected.
The bottom line is that since there is a pretty solid consensus that rates will remain steady going forward, whether or not the BOE cuts rates might not have as big of an impact on the market. In the end, the relative confidence in the banking sector could have a bigger role to play in the direction of the pound over the coming weeks.