Is a BoE rate hike next month a done deal?

At the beginning of April, the markets were pricing a 0.25% rate rise in May as a near certainty. However, the MPC voted 7-2 in favour of keeping the bank rate at 0.5% whilst also electing to keep the bank’s asset purchase scheme unchanged. The decision came in the wake of a series of disappointing data releases throughout April which showed the UK economy growing just 0.1% in Q1. Keeping policy unchanged was widely expected by the time the meeting was held and consequently had little impact on sterling (although the pound had weakened considerably in anticipation of the outcome during the month prior).


Looking ahead at next week’s BoE rate announcement (2nd August at 12.00pm) the futures market is currently pricing in an 85% probability of a 0.25% hike. We agree that the long-anticipated rate hike is the most likely outcome, but fear that 85% overestimates the probability and leaves the pound vulnerable to a significant fall in the event that the MPC votes to keep rates unchanged.


Why are we cautious?  


1. Economic data – A quick glance at the table below shows little difference between the data released in April and the latest numbers released in July. In fact, on many measures, there appears less justification for a rate rise in August than there did in May. For example, headline inflation is currently running at 2.4% compared to 2.5% in April and the recent trend has been lower. Core inflation (excluding the volatile food and energy components) is now below 2%. Unemployment has held steady, but average earnings has fallen from 2.8% to 2.5% suggesting demand driven inflation is likely to be lower in the months ahead.





2. Brexit uncertainty – As 29th March 2019 draws ever closer, the uncertainty surrounding Britain’s departure from the European Union is becoming a growing concern. Theresa May’s Chequers deal has been met with strong opposition internally and seems highly likely to be rejected by Michel Barnier. Whether a trade deal is possible remains to be seen, but an increasingly large number of businesses are reportedly planning for a return to WTO rules for their dealings with Europe. Given that the Bank of England felt the need to cut rates in the immediate aftermath of the Brexit vote, it seems slightly surprising that the committee should feel able to raise rates now (unless of course, they’ve decided that Brexit doesn’t have to be the economic disaster that was once feared).



3. History – Carney has a reputation of failing to deliver. Whether it during his time as Governor of the Bank of Canada or more recently, as Governor of the Bank of England, Carney has a history of saying one thing, but then changing his mind at the last minute.


What would a vote of no change mean for sterling?


Given that the market is pricing in an 85% chance of a rate hike next month, a vote to keep policy unchanged will certainty have a negative impact on the pound. To what extent, will largely depend upon what is said in the accompanying statement/minutes/quarterly inflation report about policy going forward.



CHART – GBPUSD (blue) vs GBP 3-year swap rate (orange)


Source – Bloomberg



The chart above shows the relationship between the GBPUSD exchange rate and the 3-year sterling interest rate swap rate. The chart shows a broad correlation between the two although the relationship has not been as strong of late implying that GBP rates are not the sole influence at the moment. The recent strength of the dollar (fuelled by Trump’s fiscal stimulus coupled with the Fed’s reduction in monetary stimulus) is one factor while uncertainty surround Brexit is a second weighing on GBP. Either way, history suggests that sterling will come under pressure if the BoE decides not to raise rates.



Our outlook for GBPUSD remains moderately bearish and assumes that the MPC do raise rates next month. Looking further ahead, our bearish stance on GBPUSD is more to do with a bullish outlook for the USD than a bearish outlook for sterling (our GBPEUR forecast is moderately bullish). That said, the outlook for UK monetary policy and Brexit negotiations both pose significant downside risks for sterling which should not be ignored.    



Author: Marc Cogliatti


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