Bank of England preview: Will Bailey surprise markets with another 50bp hike?

The Bank of England announce their latest monetary policy decision on Thursday 3 August, with markets widely expecting to see rates raised further in a bid to drive down inflation. This article takes a look at the key elements of this announcement and considers how to trade it.

The UK remains the problem child of the West as things stand, with the economy only recently back to pre-pandemic levels and inflation running red hot despite recent declines. There has been a notable shift in tone from markets in the wake of the latest UK inflation release, with forecasters signalling a growing expectation that the Bank will opt to raise rates by 25-basis points rather than the 50-basis point move seen last meeting. But this is by no means a certainty, with markets pricing a 66% chance of a 25bp move, and 33% probability of a 50bp hike. That split provides grounds for volatility as there will be a repricing for a significant section of the market either way. Let’s take a look at the factors and consider what the BoE may do.

Firstly, the Bank of England need to weigh up whether their current monetary policy conditions go far enough to drive down inflation as things stand. The chart below highlights the fact that the Bank of England’s headline interest rate of 5% stands well above the likes of the ECB and RBA, but in the same ballpark as the BoC (5%), Fed (5.5%), and RBNZ (5.5%). This means that they could quite happily raise rates to 5.5% without believing they are taking extreme measures. In fact, expectations of another FOMC hike this year does signal the high likeliness that the BoE will similarly move towards the 6% level soon enough.  

However, the UK and US are in very different situations. The US GDP release seen last week highlighted an economy that continues to push forward despite the pressure of rising interest rates. The UK has managed to outperform many of the predictions of a 2023 recession, with recent IMF projections actually upgrading UK growth. While the latest PMI figures are grounds for concern, the economy has proven more resilient than many had imagined. The housing market will be key going forward, with elevated rates feeding into housing costs to drive down consumption over the term of that mortgage. Therefore the key for the Bank of England is to drive down inflation as quickly as possible to ensure the ability to swiftly switch onto a more supportive footing if necessary.

Unfortunately, the UK inflation picture remains troublesome, to say the least. Traders seemed willing to celebrate the decline of headline CPI this month, figuring that the move from 8.7% to 7.9% would bring a notable change in outlook going forward. However, it is safe to say that markets were less optimistic when inflation reached this same 7.9% reading last year. The key element was clearly the size of the decline, as it may signal the potential for a more dramatic push towards the 2% target. However, with headline inflation at 7.9% and core CPI only moderately declining to 6.9%, the Bank of England has a serious problem on its hands. High wage growth in the services sector looks likely to provide a particular issue in the UK, with the smaller manufacturing base meaning that declining input prices (PPI) provide less of a benefit. In many ways, the BoE need to damage economic confidence in a bid to weaken wage growth and avoid an inflationary spiral. The slower they act, the more inflation becomes ingrained.

With the Bank of England under pressure to drive down inflation quickly, it is important to note the role of the pound in all this. A weakening pound played a role in driving up inflation at the onset of this crisis, with a strengthening dollar essentially raising the price of foreign imports. However, a strong pound provides a helpful disinflationary boost for the Bank of England, with foreign goods becoming cheaper for UK consumers. This means that there is a benefit to Bailey and the MPC in keeping sterling elevated. Aside from the rate decision, the outlook and Q&A provide an opportunity to support the pound. A hawkish outlook would likely serve to both drive the pound higher and promote caution for businesses in terms of salary demands. That highlights the potential for either an oversized 50-basis point hike, or a hawkish 25-basis point move alongside commentary that encourages the idea of further tightening. Either way, it is in the interest of the Bank of England to ensure the pound gains ground on Thursday.

GBPUSD technical analysis

The pound has been under pressure over the past two weeks, with the UK CPI release seeing sterling long unwound. However, this does provide a potential bullish opportunity given the long-term uptrend in place. The ascending trendline support has come into play around the 61.8% Fibonacci support level, raising the likeliness of a resurgence here. With the Bank of England incentivised to lift the pound this week, the bulls are likely to feel emboldened ahead of this release. A decline through trendline support would be required to bring about a more pessimistic view.