The BOE is still expected to follow through with a rate cut at its Thursday meeting. But, the eventful budget, and the subsequent market reaction, has led to a change in the outlook for the next year. With bonds firming up and traders expressing their concerns about government spending, the Bank of England could set off some volatility in pound pairs depending on how it handles the event.
Since traders are mostly focused on what will happen next, the market reaction could hinge once again on the vote count. A larger majority voting to ease will likely get the markets thinking more cutting will be the theme next year, and that could push the pound down. On the other hand, a more split vote could leave markets pricing less easing and support the pound. And there is always the chance of a major upset, in that the BOE opts to not cut rates, even if it’s by a small difference in votes. That could not only send the pound higher, but significantly shake up the markets.
Not the (mini) Budget Again
Part of the market’s potential reaction could lie in understanding why it moved the way it did after the Budget. The benchmark 10-year gilt trended lower during the actual announcement of the budget, but then spiked higher in the days after. It’s no-where near as dramatic as Truss’ infamous “mini-budget”, but the return of risk premiums has provided an echo. And it means the so-called are flexing their muscles.Though, to be fair, part of the move is coincidental as comparable yields rose amidst geopolitical uncertainty. But investors were unhappy with the size of the increase in taxes and spending in the Budget, including Chancellor Rachel Reeve’s admission that she’d been ‘wrong’ to promise not to raise taxes in the campaign. Although now she is again pledging not to raise taxes, markets seem to be considering further fiscal measures might happen. That implies future risk of inflation, plus the added risk that a global slowdown could pinch British finances severely and raise the nation’s sovereign risk. All of that raises bonds, and by extension the pound.
What Does This Do for the BOE?
The last time there was a spike in gilt yields in the wake of the budget, the BOE was forced to step in and essentially do an emergency QE measure to force down rates. The move isn’t as dramatic this time around, but the rise undermines what the BOE is trying to do with lowering rates in order to support the economy. The tightening in the yields is likely to be temporary, and therefore the BOE could decide to stick to its current easing path. At least, that seems to be the opinion of economists and of the futures market.
A unanimous vote to cut would likely be seen as more dovish than anticipated, and push the pound lower. The Budget is expected to add to inflation, meaning the BOE will take a slower course of lowering in the coming months. So, a strong easing signal might catch the markets by surprise.
On the other hand, a 5-4 split in favor of easing might be interpreted by the markets as the BOE being more concerned about inflation. That would be a shift from prior readings, where the BOE was seen as generally satisfied with the slow normalization of consumer price increases. This could bring in speculation that the BOE might not cut at the next meeting, as inflation is expected to rebound in the coming months.
