Cable has been trending lower over the last month as investors evaluate the differing rate outlook for the Fed and the BOE. With the Fed widely expected to hike amid a solid economic profile, the BOE’s potential rate is not as supportive of the pound, dragging on the GBPUSD. The major test for the currency pair is this week, with the BOE following the Fed’s rate decision by a single day.
However, there is a solid consensus about the upcoming meeting, which means the market reaction will depend on what the BOE signals for its September meeting. And there, the picture is much more uncertain. Economists and the market are at odds, which means there is a high chance that the market will move after the meeting. Given the more hawkish expectations from the market, chance of a dovish surprise becomes higher.
What Are the BOE Hike Odds?
Economists are unanimous and the market agrees that there is no chance the BOE will hike rates at the end of its policy setting meeting on Thursday. That’s as far as the agreement goes, however. Economists are also unanimous in expecting the BOE to hold at the next meeting in September, while markets are putting the odds of a hike at around two-thirds. Futures price in at least one rate hike by the end of the year, while economists do not see any hiking until at least next year.
Generally, the central bank, staffed with economists, tends to side with the economists, which means there is a high chance of a dovish surprise. UK inflation came in cooler than expected, which further reduces pressure on the BOE to hike. However, the odds of a hike rose as investors priced in potential future pressures from energy prices as the war in the Middle East shows no sign of ending soon.
The Vote to Be the Decider
The BOE’s Chief Economist, Huw Pill, seems to agree with the market, however. At the last meeting, he was one of two MPC members who dissented, voting for a hike. Since then, he’s maintained that there is a risk of inflation overshoot, suggesting he will vote the same at the upcoming meeting.
Markets seem to be expecting a similar 7-2 vote split on Thursday. If that’s the case, then the reaction will likely be minimal. But, if there are more votes dissenting in favour of a hike, that could be seen as a hawkish surprise. On the other hand, if the decision is unanimous, or if there are even some dissenters for easing, then that would be a dovish surprise.
How the Market Will React to the BOE Rate Decision
Besides the vote split, what could also move the market are comments from Governor Andrew Bailey. To support expectations of a hike in September, he will likely have to provide some kind of hawkish signal or suggest that a move is imminent. However, if he provides a more ambiguous message, then the market could see it as dovish.
The issue for the pound is that if the BOE hikes in the second half of the year, this would weigh on an already sluggish economy, altering fiscal hawks. Britain’s finances are already under pressure from expected spending increases under the new government, and a rate hike would likely slow tax receipts as the economy falters. So, a dovish surprise could actually end up supporting the pound, at least after the initial knee-jerk reaction fades.
