BoE Scale-Down Quantitative Easing. Which Direction Will the Pound Go?

The centre of attention for This Week’s Market Focus is the Bank of England’s Interest Rate Decision, which will be unveiled tonight. The market expects the BoE to announce a 25 basis point hike at this week’s interest rate meeting. If the Bank of England raises interest rates at this week’s meeting, it will be the third time it has done so. However, whether the BoE will raise interest rates tonight is still to be decided by the monetary policy committee members. 

At the same time, the market is concerned about when the Bank of England will begin to reduce its bond purchases. Once the BoE officially announces the reduction of its bond purchases, it will have a crucial impact on the bond market, significantly boosting the pound. JPMorgan produced a forecast indicating that demand for central bank bonds in the United States, the United Kingdom and the eurozone would fall by $1.7 trillion this year and $2 trillion in 2023.

The game of soaring inflation and recession

Similar to the United States, the UK is currently mired in high inflation, with fears of a recession and the reality of high inflation repeatedly shaping the Bank of England’s policy decisions. The Bank of England’s continuous interest rate hikes are driven by a sharp rise in inflation. The current UK inflation rate is at its highest level in 30 years, soaring to 7% in March. The inflation data also reflects the negative economic impact of the Russian-Ukrainian conflict on the energy and food supply chains, among other supplies in Europe.

uk inflation

(Source: Bloomberg)

Inflation in the UK has kept soaring in April, with economists expecting inflation to be as high as 8% in April this year. However, JPMorgan economist Monks believes that UK inflation has risen much more and is likely to increase by up to 9% in April, hitting this year’s peak. Furthermore, considering that household energy prices are expected to increase by 30% in October, inflation will remain high until the end of the year.

Energy and food prices are the leading causes of soaring inflation in Britain. Since 1 April 2022, the price limit on fuel used by ordinary households in the UK has risen sharply. As a result, the annual energy price cap rose by around £700, or 54%, compared to previous figures. Coupled with the food crisis sweeping across the UK, there will be a massive contraction in the food industry due to rising prices, threatening the UK’s future food security.

Britain’s economic growth is slowing as it is expected to grow by 3.6% in 2022, nearly half the 7.5% GDP growth rate achieved in 2021. The UK labour market remains tight, with many people choosing to leave the labour market as rising prices outpace wage increases. In addition, at today’s meeting, the Bank of England may give more guidance on how it plans to reduce the bonds worth £847 billion it is holding within the interest rate decision. Tightening policies such as interest rate hikes and balance sheet reductions may further pressure economic growth. The Bank of England needs to find the best balance between spurring economic growth and curbing inflation.

What is the Sterling pound’s future?

The Bank of England was the first central bank to announce a rate hike to curb soaring inflation. Since then, it has proven difficult to stop the pace of interest rate hikes. The market expected a 50 basis point rate hike in the next BoE monetary policy meeting to fight soaring inflation, but expectations have risen significantly. Many now believe that the Bank of England could raise interest rates by 75 basis points at the March and May meetings. However, due to the ongoing fears of a recession in the UK, it is unlikely that the BoE will unveil a radical rate hike policy. Still, the pace of future rate hikes may remain high due to the record-high inflation.

The upside opportunity for the Sterling pound in the future is still enormous. However, it remains to be seen what the final decision of the Bank of England monetary policy meeting will be. Many expect another rate hike from the BoE will help the pound keep rising. However, with the current high inflation levels already dealing a severe blow to consumer confidence in the UK, the BoE’s stance on rate hikes may not be too hawkish, limiting the pound’s upside.

Earlier rumours that the Bank of England will begin to reduce its holdings of gilts at this meeting may not be accurate. Instead, the Bank of England is expected to outline its plans to reduce the £875 billion of British government bonds it is holding. In addition, the central bank will let the markets know its plans in terms of currency tightening, which will also increase the chances of boosting the pound. As the UK begins to shrink its quantitative easing portfolio in the future, traders are also betting on higher future borrowing costs.

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