4 August 2022 – The Bank of England is set to announce its interest rate decision. The market expects the Bank of England to raise interest rates by 50 basis points today, while some think it will only raise interest rates by 25 basis points. Governor Andrew Bailey told the media that while there was “no lock-in” for a 50 basis point rate hike this week, it would be one of the options discussed before a final decision is reached tonight.
Earlier data from the Office for National Statistics showed that the UK consumer price index (CPI) rose 9.4% year-on-year in June, hitting a 40-year high. The market is worried that the upward inflation trends will persist. If the pace of interest rate hikes is not as aggressive as the market expectations of a 50 basis points hike, the pound may weaken further.
Many factors constrain the pound’s movement, and there is no guarantee that raising interest rates will boost the pound. First, the market is pessimistic about the prospects for the UK economy. The International Monetary Fund (IMF) has warned that the UK could become the G7 economy with the slowest GDP growth rate in 2023 among the seven wealthiest nations. The IMF forecasts that UK growth will fall to 0.5% in 2023, well below the 1.2% figure in April. The slow growth expectations will significantly limit the extent of the BoE’s subsequent interest rate hikes despite the extremely high inflation levels in the country. The BoE raising interest rates further could exacerbate the UK’s economic recession.
Second, inflation in the UK is still likely to continue rising. Additionally, it currently exceeds the US and Eurozone inflation figures. Ofgem had earlier suggested that more frequent adjustments to price caps would help consumers benefit more quickly from lower wholesale prices. However, such a move would also increase prices at a similar pace. Tightened gas supplies from Russia have kept UK energy prices high. The situation is likely to worsen with the onset of peak natural gas use in the upcoming winter season. The market believes that the future inflation levels in the UK will continue to soar, and the shocks to the economy will persist.
In addition, if the Bank of England raises interest rates sharply, it may increase the debt repayment pressures of the United Kingdom. Although it may not lead to a debt crisis at the moment, it will affect British consumers’ confidence and negatively affect the pound. The election of a new British Prime Minister is also the focus of market participants, especially the position of the two candidates on taming inflation. Still, the political factor will have a short-term impact on the pound, mainly depending on the US dollar’s performance.
Overall, the short-term downside risk to the pound is still relatively large. Therefore, it is difficult to say that raising interest rates will create upward opportunities for the pound. However, if the BoE takes a very hawkish stance and chooses to raise rates by 50 basis points, the pound could get a short-term boost.
However, the performance of UK economic data after the interest rate hike is something that investors must pay attention to. Whether higher borrowing rates will drag down the economy and ease inflation will be reflected in future data releases, which may cause follow-up pressure on the pound.
The US dollar constrains the pound’s current trend. The United States will release a series of economic data this week, reflecting the economic impact of the Federal Reserve raising interest rates sharply twice in a row. There is still significant uncertainty about the dollar’s prospects. In particular, the US non-farm payroll data will be released this week. Suppose the labour market data is better than expected, the Fed’s interest rate hikes will be justified, allowing the dollar to regain its upward momentum. A strong dollar would put pressure on the currencies of other countries, including the pound.
