Although it is not alone in this view, the Bank of England (BoE) is increasingly concerned about rising inflation. In recent weeks, there has been a growing feeling that the Monetary Policy Committee (MPC) will need to act to curb the negative impact of inflation on the UK economy. This rate hike potential has allowed GBP to build support in recent weeks and is now at a key crossroads in its recovery.
- Inflation driving more hawkish comments from the Bank of England.
- A rate hike is now possible in November
- GBP has rallied to a crucial technical crossroads level on Cable.
More hawkish BoE stance coming
There was a hawkish surprise element to the September BoE meeting when Dave Ramsden joined Michael Saunders to vote in a reduction of the target level of bond purchases. Although there are unanimous views of keeping interest rates on hold, this was a step in the direction of tightening.
In recent weeks, inflationary pressures have continued to build and the views on the MPC seem to be shifting towards taking action. Crucially the hawkish noises are coming from Governor Bailey, who said over the weekend that policymakers “will have to act” on inflation.
Inflation has risen above 3% and could easily be between 4% and 5% in the coming months. Although there is still a transitory nature to the rise, given the impact of high energy costs, this could have a longer-lasting impact on consumers. So, this Wednesday’s UK CPI reading will be very closely watched by the MPC. Any upside surprise to forecasts which suggest headline and core holding steady at 3.2% and 3.1%, will be of concern to the MPC and hasten the tightening. This would likely drive further GBP recovery.
Rate hike potential this year
Following Bailey’s comments, expectations of a rate hike in the coming meetings have grown significantly. This chart shows the difference just from Friday, with a sharp steepening of the UK Short Sterling Interest Rate (a reflection of UK interest rate futures). This chart shows interest rate futures markets pricing for +15 basis points by the end of the year and potentially three more +25bps hikes to leave the interest rate at 1.00% by the end of 2022.
(N.B. rate futures work back from 100, or zero rates; so an interest rate of 0.25% would be read as 99.75)
The prime meeting for a hike would be a “Super” meeting (with the press conference and quarterly inflation report, which are held on alternate meetings). However, this means November and February would be preferred options. November may come a little too soon, but if inflation continues to soar next month, it could mean December is still open.
This hiking potential has suddenly thrust the Bank of England into potentially needing to be (by no choice of its own) one of the most hawkish major central banks. We would though still err on the side of caution/reluctance over BoE hikes. Especially as it would be hiking to battle inflation that could still be transitory. The threat of choking off economic recovery to combat inflation is certainly not the desired path.
Amidst this increased potential for tightening policy, GBP has been performing well in recent weeks. Since there was a shift in sentiment away from USD at the end of September, GBP has performed almost as well as the commodity currencies (AUD, CAD and NZD) which have all been boosted by the gains in commodities.
Technically GBP has rebounded and is now around a key crossroads. On the GBP/USD chart, Cable is now up to a crucial medium-term confluence of barriers to overcome. Resistance in the band 1.3730/1.3800 coincides with a four-month downtrend and the RSI is into the mid-50s. These are all key factors that need to be overcome if the recovery can continue higher.
Trading consistently above 1.3800 opens 1.39/1.40 resistance. If the RSI can move into the 60s then this would also be a key signal that confirms the recovery was moving into the next bull phase. The buyers will be keen to build support above 1.3670/1.3700 but certainly above the 1.3570 key higher low area now.
GBP has been strengthening on the back of increased potential for rate tightening in the coming months by the Bank of England. If this week’s UK CPI data comes in hot, it could be another catalyst in the recovery of GBP.