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BOE Expected to Hike After CPI Figures

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The consensus that the BOE will hike at the meeting on Thursday is pretty near unanimous. Where rates go after that is subject to intense debate, with the market and economists (and, potentially, the BOE) having different views. All of this could shake up the pound, especially if inflation is not in line with expectations tomorrow.

Where the disagreement lies

According to surveys by both Reuters and Bloomberg, the consensus among economists is that the BOE will reach a terminal rate of 5.0%. That means one hike at this meeting, and one more after that. The BOE would then hold rates steady for the rest of the year, according to this view.

The market, on the other hand, expects a terminal rate of 5.75%. It even got as high as 6.0% on Friday. This means 125bps of hiking over the course of the next few months. The BOE has been hesitant to do “double” hikes, so this could mean policy would continue to be tightened almost until the end of the year. Because the market is what rules the price of the pound, it’s this view that’s supporting the current strength in sterling. So, if something were to happen to bring the outlook more in line with what economists say, it could weaken the pound.

Why such disparate views?

The issue relates to inflation expectations, and in particular how the labor market is seen affecting prices. April saw the largest (nominal) increase in wages on record, at 7.2%. That means inflation has gone on to have “second-round” effects, something that BOE Governor Andrew Bailey warned about last May.

Second round of effects is when inflation causes employers to demand (and get) higher wages. Which means they have more cash to continue shopping, which in turn keeps prices higher. This is the incipient “wage price” spiral that worries many central bankers. The conventional wisdom is that it takes even higher rates to put an end to a wage-price spiral. It’s likely that market participants are looking at the tightness in the labor market and betting that wages will keep rising. This will practically force the BOE to keep hiking, even if there is an economic downturn.

How the data could change things

Economists suggest that inflation in the summer could come down naturally, partially thanks to base effects. That’s because inflation rose quickly last summer, driven by energy costs. If prices were to keep rising, but at a slower pace, it would bring inflation down. Other seasonal reasons for high inflation, such as the poor weather in Spain in spring, could also help bring grocer prices back to more normal levels.

A lot, therefore, hinges on the CPI figures that come out ahead of the BOE’s meeting. If inflation shows that it’s going strong, then it would imply the market is right, and boost the pound. The expectation is for a mere 3 decimal drop in inflation, so it wouldn’t take much to even show inflation has actually increased. That would likely send shockwaves through the markets, and rase bets for rates even higher.

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