Sterling in a Firm Position Ahead of BoE Decision
- Core and headline inflation remain uncomfortably high despite easing on the headline front. Base effects likely to see sharper fall into second half of the year
- Two-year fixed mortgage rate hits 6%. Average mortgage payments set to rise by £2,900 a year
- GBP/USD appears in the pound seat as yield differentials elevate cable’s attractiveness
- The analysis in this article makes use of chart patterns and key support and resistance levels. For more information visit our comprehensive education library
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Another 25-Bps Hike on the Cards for the MPC
The Bank of England’s (BoE) Monetary Policy Committee (MPC) is due to hike interest rates by at least 25 basis points on Thursday midday, according to market expectations. In fact, there is even an outside chance (27% probability) that they could even hike by 50 bps but that is not the base case scenario.
Implied Probabilities of 25 and 50-bps Hike via Rates Markets
Source: Refinitiv, prepared by Richard Snow
Inflation Remains the Driver Behind Another Rate Hike
Despite seeing a welcomed move lower in headline inflation, widespread price pressures observed in the services sector (restaurants/hotels plus food and non-alcoholic beverages) and upward trending salary growth must come down. A wage-price spiral is a central banker’s worst nightmare and seeing UK average earnings maintain its broader upward trend will have several BoE officials worried.
UK Average Earnings (3-month average) Year on Year Change
Source: Refinitiv, prepared by Richard Snow
In addition, UK core inflation has marked another leg higher according to the April figure and the May data is expected to show no improvement with a forecasted figure of 6.8%. UK core CPI in the chart below reveals widespread prices have been heading in the wrong direction as the United Kingdom’s peers experience differing degrees of disinflation.
UK Core CPI vs Other Developed Economies
Source: Refinitiv, prepared by Richard Snow
BoE Revised Forecasts on Growth Higher, Unemployment Lower
At the May 11 meeting, Bank of England officials revealed the largest upward revision to UK GDP on record, rising to 0.7% expected growth in Q2 of 2023 compared to the 0% forecast in the February version of the report. Better than expected GDP - while not stellar by any means – suggests that it may take longer for previous rate hikes to dampen demand and overall economic activity with the goal of lowering inflation.
Source: Bank of England
Another observation of note within the forecast was the downward revision to the unemployment rate, both in Q2 this year and Q2 2024 - underscoring a tight and resilient jobs market. The latest unemployment data corresponding to March bore testament to the forecast, revealing a surprise to the upside when 250k jobs were added to the economy versus the 162k addition expected.
Source: DailyFX
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BoE Forced to Hike Despite Rapidly Increasing Mortgage Payments
The issue of rising mortgage repayments was the subject of debate in the House of Commons today as UK Finance Minister Jeremy Hunt ruled out any new direct support from government for those struggling to keep up with increasing interest-related payments. Instead, he referred to existing government support measures in place and stressed the dangers that further government borrowing/spending would pose in the fight against inflation.
Governor Andrew Bailey is likely to face similar questions after the monetary policy statement is released on Thursday but is armed with the Bank of England’s mandate which is to protect price stability as well as financial stability. Hiking interest rates remains the Bank’s most effective tool in calming rampant inflation.
In the prior policy statement, the committee assessed risks to the inflation outlook remained skewed to the upside. Again, they stressed that if there were to be evidence of more persistent pressures, then further tightening would be required. The use of the word ‘would’ instead of ‘may’ suggests that the hiking cycle still has a few more legs higher to go. However, past rate hikes are likely to weigh more on the economy and with inflation expected to drop sharply, the MPC may open the door for language that accommodates the possibility of nearing the peak in rates.
Markets anticipate around 130 bps more of hiking which would effectively propel the UK bank rate above the US at 5.75%, although, officials have mentioned that such expectations are optimistic.
Cable in the Pound Seat Ahead of BoE Decision as Yield Differentials Support Sterling
The pound sterling has enjoyed a sizeable rise against the US dollar in recent times as markets appear to be overestimating the extent of BoE hiking and possibly under appreciating the Fed’s hawkish message that accompanied its improved economic projections.
On the GBP/USD chart below, the black line represents the yield differential between the US and the UK (the 10-year gilt yields minus the 10-year treasury yields). UK rates have been outpacing the US which could help support sterling in the coming trading sessions. This week a countertrend move in FX markets sees cable trading lower, towards the zone of support around 1.2700 which could set the scene for bullish continuation setups after the announcement.
Bear in mind that markets currently price in slightly more than a 25% chance of a 50-bps hike, meaning we could see cable repricing slightly lower after the announcement. Resistance appears all the way at the psychological level of 1.3000.
GBP/USD Daily Chart
Source: TradingView, prepared by Richard Snow
| Change in | Longs | Shorts | OI |
| Daily | 17% | -12% | -3% |
| Weekly | 0% | -5% | -3% |
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--- Written by Richard Snow for DailyFX.com
Contact and follow Richard on Twitter: @RichardSnowFX
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BoE Preview: Inflation Demands More Hiking Despite Mortgage Pain - DailyFX
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