With Bank of England policymakers signalling that the central bank is moving towards an early interest rate hike, traders have been trying to figure out what this means for the pound. Economists and forex analysts have offered both positive and negative comments about the bank’s intention to raise interest rates, with other analysts turning neutral.
Interest rate rise could hurt the pound
Markets are now expecting the BoE to raise interest rates in November, with further rates to follow by the end of 2022. However, the link between higher interest rates and a stronger currency has been broken, unfortunately, due to the current energy crisis, higher costs and a struggling economy due to the pandemic. Within this environment, many analysts are concerned that an early rate hike will actually create more problems and that it could be reversed within two years, creating further uncertainty for the currency.
Jane Foley, head of foreign-exchange strategy at Rabobank, said that “There is a lot of uncertainty,” in London. “It’s easy to argue that rates going up will strengthen the pound. But the risk of a policy mistake means the BOE could hike soon but then won’t be able to follow through” with more tightening.
Bank of England Policy Mistake?
Markets are unsure about the outlook for the pound, with institutional fund managers limiting their trades against the pound and others betting for the pound to strengthen. For some analysts, the BoE tightening will provide some support for the currency but, for others, the lack of economic growth will eventually reverse any gains.
Additionally, further challenges remain. Brexit tensions between the UK and the European Union over Northern Ireland could escalate into a trade war, but Prime Minister Boris Johnson has offer assurances that solutions will be delivered within the week.
Despite the Bank of England’s Governor Andrew Bailey’s reassuring comments that the Bank will do what it takes as inflationary pressures rise, traders are concerned about the pound outlook in the longer term.
Pound remains “insensitive” to UK rate expectations
While many foreign exchange analysts have voiced their concerns about the pound outlook if the Bank of England proceeds to an early set of interest rate rises, HSBC strategists believe the pound is “insensitive to the continued hawkish drift in UK rate expectations.” Even if inflation falls at the end of 2022 and there is no need to raise rates higher on a long-term basis, HSBC says there is more to the pound than an automatic fixation on the BoE.
Indeed, the pound is not driven solely by the desire of the Bank of England to raise or not rates. A they argue, the pound’s performance has been mainly determined by global forces. It rises against the euro and US dollar on positive investor sentiment and falls when global markets struggle. As investors recently digested global concerns about the pandemic and the energy crisis, buying interest for the pound has returned, pushing Sterling higher.
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