The (BOE) Bank of England will hold its policy meeting on Thursday, and there is a very solid market consensus that the result will be a hold. However, markets will be on tenterhooks about the outlook. Futures are pricing in two rate hikes this year, with June a clear possibility. If that were the case, the traders would expect the (BOE) Bank of England to give some clear indication at the upcoming meeting.
The last meeting occurred two weeks after the start of the war in the Middle East which drove up energy prices and inflation expectations. At the time, there was little information about how the war would affect the economy, and so the entirety of the MPC voted to hold rates unchanged and wait for the data. This was a dramatic shift from prior outlook, as markets were tentatively pricing in a rate cut in March as the UK economy softened.
Trying to Measure the Market Reaction
The market’s response to the last rate decision apparently came as a surprise to the BOE. Apparently, many traders interpreted a unanimous hold as a sign of increased hawkishness, instead of simply that the doves had voted to hold because they wanted more data. Governor Andrew Bailey even came out to warn that the market was getting ahead of itself in pricing in rate hikes, a view he likely still has and could express at the upcoming post rate decision press release.
The pound has been supported on the basis of more tightening, as markets are pricing in a widening of the rate gap between the US and the UK. With two rate hikes penciled in for the (BOE) Bank of England, and one cut from the Fed, the rate spread is expected to widen by 75bps this year. Normally that would send the pound soaring, but too high rates would drag on the economy, putting a cap on cable. Which means that, counterintuitively, a more dovish BOE might actually support the pound more, as it would mean still higher rates but perhaps not as high to slow the economy.
The Vote Count that Matters
The main issue that could shake up markets is the vote count. Going on the basis that prior doves voted to hold last time due to the lack of information, now that we have data from after the war started, they could change their vote. Markets might be pricing in too much hawkishness based on the last vote. A sizeable number of MPC members (say 3-4) could return to being dovish, choosing to see inflation pressure as transitory. This would likely shock the market, which seems to be pricing in a much more hawkish BOE.
Among dovish members who might vote for a hold, however, are Governor Andrew Bailey. Before the war started he held the balance between four doves and four hawks, and had the advantage of being able to clarify his vote immediately after as Governor. A similar dynamic might develop this time around, and the market might correct substantially towards dovishness.
It’s Still in the Air
The other option is that even though there is data from March, it still hasn’t painted a clear picture of what will happen with inflation. After last week’s drop in the unemployment rate and solid February GDP numbers, the (BOE) Bank of England might consider punting until June. That could lead to another unanimous vote to hold, likely confirming the market’s hawkish views.
That would likely strengthen the pound right after the decision as the market considers higher rates. But the move could fade fairly quickly as markets worry that the economy will slow and demand for pound-denominated assets declines.
