The pound has fallen since last week’s Bank of England (BoE) monetary policy decision to leave the Bank rate unchanged at 0.10%. While it is expected to stabilise the following days, analysts do not anticipate considerable gains for the pound in the near term.

The BoE’s decision to keep monetary policy unchanged took markets by surprise but it chimed with members of the Monetary Policy Committee comments that the Bank wanted to wait and see further evidence about the state of the economy and the health of the labour market, especially the impact of the furlough scheme which ended in September. Analysts still expect a February rate increase instead of one in December.

Possible interest rate rise

The BoE wants to wait and analyse the impact that the end of the furlough scheme will have on the economy, and employment in particular, before making any decisions on raising interest rates. Some of the data will become available in December and more later in January and February. This is why the November interest rate rise was too soon, whereas other ones in December, February 2022 or some time later, appear to be more likely possibilities.

Before the next Bank of England meeting on the 16th of December, analysts and policymakers will have the chance to examine two jobs reports and two inflation reports, which will determine how the Bank will act if there is to be a 15bp December hike. Since markets have not yet priced in a December move, there could be potential for Sterling to rise.

Pound outlook

Analysts believe that there is still potential for the pound as markets digest the news and adjust to a less aggressive policy response in the next meetings.

At the same time, for inflation to return to a target that will be within expectations, the Bank rate will need to rise. The Governor of the Bank of England, Andrew Bailey, said that the BoE would not raise rates to 1 per cent by the end of 2022, because according to the bank’s forecasts inflation would fall below its 2 per cent target in the medium term if they tightened monetary policy too much. Higher inflation is expected to be transitory, leading to an increase in consumer prices, which would have been higher if interest rates rose even a little. The Bank, however, does not expect inflation to fall below 3 per cent until the spring of 2023, which means there will be a period of higher inflation.

Brexit

Brexit is adding some pressure on the pound at the beginning of this week, as reports that the UK is preparing to trigger Article 16 of the Northern Ireland Protocol are growing. Senior Government and EU figures have held discussions to prepare on the possibility of the UK triggering article 16 of the Northern Ireland protocol, a move that both Dublin and Brussels expect in the coming weeks. The move could create a crisis in EU-UK relations. Minister for Foreign Affairs Simon Coveney said that the EU could retaliate by withdrawing the entire free trade and co-operation agreement, reigniting fears of a “no-deal Brexit” and tariffs on trade.

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The pound fell following the Bank of England’s decision on Thursday to keep interest rates unchanged. The decision has taken markets by surprise whose expectations for a November rate hike were very high. Markets are now lowering their expectations for future UK interest rate hikes, as it was also suggested that the December rate hike might also be postponed.

The disappointing news has hurt the pound, which experienced the biggest fall since 28th of September. With the market expecting more than one hike and the bank rate going as high as 1.10% by June 2022, the news was really unexpected. Economists believe that a December or February hike is still possible, which could offer support to the pound. On Friday, the pound remained lower, but tried to stabilise.

Bank Decision

The Bank explained that they have postponed the rate hike as they wanted to wait and see the impact of the government's job support scheme which ended at the end of September.

Uncertainties such as rising energy costs impacting households, ongoing supply chain disruptions, and Brexit tensions could all affect economic recovery. Inflation is a key concern for policymakers as  is expected to rise to around 4% in October and 5% in April 2022. The MPC stated however that inflationary pressures were “most likely to prove transitory.”

Rates could rise in the coming months

The Bank of England noted that interest rates could rise in the coming months if the economy improves. The key question now is whether the Monetary Policy Committee will announce the next rate in February when it produces its new forecasts. The possibility of a rate hike in December is just below 50%.

If there is a rate hike in December this will depend on November's job report for the October period. The labour market report on 16th of November is expected to show positive figures that reflect a healthy labour market which could support a small interest rate rise. A positive jobs report could therefore offer support to the pound.

Economists at MUFG Bank expect interest rate hikes and they have warned that the pound could fall further if the Bank fails to curb inflation. They said: “We still believe that the BoE will raise the policy rates closer to 1.00% by the end of next year. We have only pushed back the timing of our forecast for two further 0.25 point hikes in 2022, and now expect those to be delivered in May and August bringing the policy rate to 0.75%. We remain sceptical though that it will rise beyond 1.00% in 2022.”

They added that downside risks for the pound could continue building if markets become more concerned that the BoE will fail to respond to higher inflation.

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The Bank of England’s policy decision is due out at 12GMT on Thursday. The question of whether the Bank will raise interest rates today for the first time since the pandemic is on every trader’s and financial analyst’s mind. The Bank is in a difficult position as it has created uncertainty about its intention to raise interest rates and whether now is the appropriate time.

Governor Andrew Bailey’s difficult position

For many analysts, the Governor of the Bank of England, Andrew Bailey, seems to have made a mistake by exaggerating the prospects of an interest rate rise. City traders are now expecting an interest rate rise and the governor will be criticised today whatever happens. If there is an interest rate hike, it will appear that the Governor was forced to deliver it so he wouldn’t disappoint markets. On the other hand, if rates do not rise, he will be blamed for signalling that interest rates were going to rise. If rates remain unchanged, and inflation pressures prove to be temporary, then this will be the least bad alternative.

Previous Monetary Policy Committee meeting

In the last MPC meeting in September, all 9 members voted to keep rates at their current level of 0.1% as heightened global cost pressures were said to be temporary. Although nothing has changed since September, a possible reason to raise rates would be to control inflation. However, economists have pointed out that this is unnecessary as inflation goes up temporarily following events such as the pandemic but eventually things return to normal.

Rate hike could push household costs higher

A rate hike will hurt households which are already struggling with rising energy costs and could push up the cost of borrowing on credit and increase mortgage costs for those who do not have a fixed rate. With supply chain problems also affecting growth, a rate rise could also weaken economic recovery.

Some of the reasons that inflation has been higher, such as rising gas prices and raw material shortages are temporary, so it will be damaging to raise interest rates early, as some economists have argued.

Thomas Pugh, economist for RSM UK, also believes the Bank will wait and not hike today: “But at 63% probability, this is still a close call. We expect the vote to be 5v4 in favour of leaving interest rates at 0.1%. This might imply a glass half-empty/half-full policy of keeping the BoE rate at near-zero for another MPC meeting, or two, with forward guidance preparing the markets for a rate hike in December or early 2022.”

How will the pound react?

A cautious Bank that announces a rate hike in November could push the pound lower, as markets are expecting higher rates over the course of 2022. Other analysts also support the view that the pound might weaken as possibly the Bank will find it difficult to satisfy market expectations.

With the market already expecting rates to rise towards 0.50% by year end, any hawkish surprises from the Bank will be limited so the potential for the pound to rise further will also be limited.

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The pound has dropped against the euro and the US dollar ahead of Thursday's Bank of England policy meeting as investors have begun readjusting their positions.

The Bank of England will deliver its latest policy decision alongside the quarterly Monetary Policy Report and expectations for a rate rise are high.

The pound has appreciated over recent weeks on expectations that the Bank of England will push the bank rate higher by 15 basis points to 0.25%. However, the drop at the beginning of the week suggests that markets are divided about the Bank of England’s interest rate decision, as many are now expecting a delay to the rate hike or a more cautious tone from the bank.

Bank of England interest rate hike

ING economists expect a 15bp rate hike, but they believe the bank will remain cautious, as they may lower their medium-term inflation forecasts and remain divided about a rate hike. Any surprising move by the bank will push the pound lower. While members of the Bank have highlighted the need to act as inflationary pressures rise, the likelihood of a November hike has now fallen while the likelihood of a December rise has risen. This has affected the pound, which has underperformed the last few days.

The Chicago Mercantile Exchange’s measure of interest rate futures, known as BoE Watch, has noted that the possibility of a rate rise in the UK this week is 100%.

Confusion among investors

Contradictory data has confused investors over which direction the central bank will go. Financial markets show that many investors are anticipating a hike, while City economists expect rates to remain at historic lows. The views of economists are in line with MPC members Silvana Tenreyro and Catherine Mann, who have warned that an interest rate rise could threaten economic recovery which is already slowing down.

Governor Andrew Bailey, chief economist at the Bank of England Huw Pill and former Citibank economist Michael Saunders, have all highlighted the importance of acting to control inflation. Bailey has characteristically stated that the bank “will have to act and must do so if we see a risk, particularly to medium-term inflation.” Deputy governor Sir Dave Ramsden is also one of the hawkish members and supports raising rates from their historic lows. If four members of the committee are in favour of higher rates, then one more member is needed to succeed. It will be interesting to see what Deputy governor, Ben Broadbent, will vote as he has never gone against the governor in his seven years on the Monetary Policy Committee.

Deutsche bank economists also believe that the BoE would deliver its first rate hike of 0.15% and that the MPC will end its QE programme a month earlier by cutting £20bn from QE.

Others have noted that Bailey would want to avoid disappointing markets, even though a rate hike was yet not a solid reality.

The confusion about what decision the Bank will make on Thursday’s meeting is largely related to the wide range of contradictory views by various analysts and economists.

 

Pound reaction

Sterling’s performance will also depend on the inflation forecasts of the Bank's Monetary Policy Report.

If the Bank proceeds to raise rates twice, the Bank Rate will go up to 0.50% over the next 3 months, which will boost the pound.

Markets expect a number of rate hikes in 2022 which would take the Bank Rate to 1.00%, but economists have noted that they will be disappointed.

Whatever the pound’s reaction ahead of Thursday, it will set the tone in the following days, so if it remains under pressure then markets might turn pessimistic.

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The pound was stronger yesterday but dropped slightly today following the fuel crisis. The government has the army on standby to help ease fuel supply problems following days of long queues, panic-buying and pump closures. Analysts warn that this will only offer temporary relief, and that the UK needs to do more to more find a more long-term and viable solution to its current HGV driver shortage.

Analysts have noted their concerns about the impact of fuel shortages on everyday life, soaring energy prices and labour shortages which could eventually dent the UK’s economic recovery.

Petrol supply

Fears of driver shortage hitting fuel supply has led to a surge in demand with up to 150 military tanker drivers ready to deliver to petrol stations which have run dry because of panic buying. There is no shortage of fuel, but simply a shortage of fuel in petrol stations, due to a lack of lorry drivers. While this was expected to have minimal effects, the problem has been exacerbated due to the behaviour of motorists who have rushed to stations panic-buying fuel. The transport secretary Grant Shapps said there were "tentative signs" of stabilisation in petrol stations and the Petrol Retailers Association said that the number of motorists at petrol stations was beginning to calm. As Shapps noted, "Once we all return to our normal buying habits... the quicker we get back to normality." The UK is short of more than 100,000 lorry drivers which has affected many industries, especially food suppliers and supermarkets.

In a joint statement, fuel companies, including BP and Shell, have reassured the public that supplies have not been affected and that demand will return to normal levels.

Higher Inflation Could Help the Pound Rise Higher

In the meantime, the pound is expected to rise as inflation pushes higher and the BoE is forced to raise interest rates. Higher inflation is the result of a combination of factors, including supply shortages and shortages of HGV drivers. While the central bank has stated that inflation is only temporary, there are concerns that it will remain high for a longer period of time.

Bank of England Governor Andrew Bailey has expressed his concerns about the current issues with supplies that have pushed inflation higher, and he noted that the Bank is ready to act if this becomes a long-term issue. He said that higher inflation can be dealt with higher interest rates and that a rate rise before the end of this year is not impossible.

The rising energy prices that have pushed inflation higher are a major concern in the UK, and the question is whether more persistent inflation than expected will prove to be the case and how the Bank of England will change its monetary policy to respond to this. The Bank of England last week warned that their forecast for high inflation at 4.0% will be exceeded. In August, the Bank raised their peak forecast from 3.0% to 4.0%.

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The UK’s supply problems could push the pound lower despite that the market has priced in more interest rate hikes by the Bank of England for next year. The government has offered temporary visas to fuel tanker and food lorry drivers, and to poultry workers. Britain's ongoing supply chain crisis could threaten the UK’s economic recovery, and combined with higher inflation, it could post serious risks to the pound.

Visas to lorry drivers

With Christmas just around the corner, the government is seeking to avoid disruption and will provide up to 10,500 lorry drivers and poultry workers with temporary UK visas. 5,500 poultry workers and another 5,000 fuel tanker and food lorry drivers will be allowed to work in the UK for three months, until Christmas Eve. The Road Haulage Association said the government’s announcement "barely scratches the surface", and that just offering temporary visa for a limited period "will not be enough for companies or the drivers themselves to be attractive." Director of the HGV Recruitment Centre, Marc Fels, said visas for lorry drivers were "too little" and "too late." The move is, however, a huge step forward in providing a temporary solution to supply chain disruption. The government has also requested from the Ministry of Defence examiners to increase HGV (heavy goods vehicle) testing capacity and sent one million letters to drivers who have an HGV licence to return to the industry. 

Various industries such as supermarkets and food chains have reported shortages of lorry drivers, while fuel deliveries have also been affected, with queues at petrol stations as consumers are panic buying despite calls from the government that the UK has plenty of fuel.

Petrol Crisis

Transport Secretary Grant Shapps has stated there was enough fuel and that people should only fill up when needed to avoid creating shortages. He said there were no supply problems at the six refineries and 47 storage facilities, and that drivers and motorists needed to “be sensible.” With the petrol crisis deepening, ministers have been forced to suspend competition law to help oil companies support petrol stations that are running dry, after days of panic buying. Following a meeting with oil companies on Sunday, business secretary Kwasi Kwarteng agreed to allow companies in the oil industry to work together, sharing information to keep petrol stations topped up.

The panic buying and shortage of drivers has also led the government to consider an emergency plan. The prime minister and senior members of the cabinet will examine “Operation Escalin” after BP reported that a third of its petrol stations had run out of the two grades of fuel, and the Petrol Retailers Association (PRA), said that 50% to 90% of its members were also running out, with more to follow.

Operation Escalin was first conceptualised as part of the planning for a no-deal Brexit, and involves  hundreds of soldiers being drafted in to drive a reserve fleet of 80 tankers. The Prime Minister will consider the Escalin and other proposals on Monday afternoon, in a meeting where ministers will also discuss ways to stop people from panic buying. Shortages could continue if people’s behaviour did not change.

The UK could also face a national shortage of turkeys in the run-up to December, with labour shortages due to Brexit.

 

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Despite Sterling rising yesterday following the Bank of England’s positive tone and the prospect of an early rate hike in 2022, on Friday it fell.

Asian and European stock markets were also down on Friday as well as risk-oriented currencies as the potential default of Evergrande can have significant repercussions on markets.

Pound and BoE

After the Bank of England’s meeting on Thursday, markets have brought their expectations forward as now the BoE is expected to start a rate hike cycle with a first increase in May 2022, followed by a second one in November 2022. While there are still uncertainties ahead for the pound, the British currency is still forecast to strengthen against the US dollar and the euro over the medium-term, as some analysts believe.  

Rate hike expected in early 2022

With markets now pricing in the first rate in the first quarter of 2022, the pound will find support, despite questions about the country’s economic recovery. Challenges will continue to exist, including unemployment and labour shortages that have become more prominent due to Brexit. Some analysts believe that if unemployment does not rise then the Bank’s Monetary Policy Committee could even add a small rate hike as soon as February. With market expectations for a rate hike already priced in, it is likely that the Bank will have to raise rates in early 2022 as it could otherwise create confusion and push the pound lower. For example, big banks such as JP Morgan have brought their expectations forward for a rate rise in early 2022 following the Bank’s announcement yesterday. Capital Economics said: "The Bank is moving closer to raising interest rates. As such, we now think that rates could rise in early 2022, rather than in 2023 as we had previously thought." They also added: "Given the gloomy tone of the recent news on economic activity, we had expected the MPC to place some weight on the downside risks to GDP growth.” However, the Bank’s minutes stressed price stability and the inflation target which remains the same. The Bank highlighted that growth uncertainties were external and depended on global supply chain limitations.

For Sterling, any news about when the rate hikes will start or the vote on QE will be key. Both Dave Ramsden and Michael Saunders voted to lower the purchase rate to £840bn instead of the £875bn. The fact that two policymakers want to tighten the policy is important.

Earlier interest rate hikes will offer more support to pound

With interest rate expectations and a first rate to take place for Q1 next year, the pound is expected to find support. It could rise even further if such expectations move even more forward.  While raising interest rates might not affect inflation, what other Central Banks do does have an effect on global markets and policy. The ECB and the Federal Reserve have both announced that they will begin the tapering and reduce their stimulus support, and if the Bank of England does not follow suit the pound could go lower, something that could push inflation to rise and import prices to go higher.

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The Bank of England remains on track to raise interest rates in the first half of 2022. The pound rose against the euro and US dollar following the bank’s update to keep rates the same. The Monetary Policy Committee voted 9-0 to leave the Bank rate at just 0.1% and to maintain its quantitative easing bond-buying programme at £895bn. Deputy governor Dave Ramsden and Michael Saunders, voted against this, as they wanted to stop the QE programme early by reducing the amount of UK government bonds the BoE buys. While the bank was not 100% yet positive as there are uncertainties about the global economy and the labour market, the pound is expected to regain some of its losses but not to climb to new highs.

According to Bloomberg, City traders have revised their forecast for the first interest rate to 0.25% after the Bank of England’s outlook for the UK economy has improved and that tightening of its QE programme could commence soon.  After Thursday’s meeting, markets now expect a 15-basis-point increase in March 2022, a month earlier than their expected one for May. They also expect a rise of 0.5% in November 2022. With markets now pricing an increase in March and two hikes by the end of next year, investors will be focusing on the bank’s November meeting when a new set of forecasts will be announced.

Inflation

The Bank of England has warned that inflation will rise above 4% by the end of this year, due to the energy crisis. The rise in gas prices is considered a risk to its projections for inflation and it has warned that inflation could remain above 4% into the second quarter of next year making things harder for households. The MPC expects that global cost pressures would prove temporary.

Growth forecasts lowered

The Bank of England has lowered its growth forecasts as supply chain problems are impacting output. Expectations for growth in the third quarter have been revised from 2.9% to 2.1%. The Bank has warned that supply problems such as access to raw materials and staff shortages are affecting economic growth. The Bank also highlighted that global recovery has lost momentum and inflationary pressures will continue.  

Tightening monetary policy

The case for tightening monetary policy seems now stronger. Consumer price inflation rose to 3.2% while global cost pressures and supply problems are pushing consumer goods prices higher. CPI inflation is expected to fall back to the bank’s 2% target in the medium term, but the bank has also pointed out that: “Indicators of households’ medium-term inflation expectations have increased in recent months, with the Citi/YouGov five-to-ten year ahead measure at its highest level since 2013 in September.”

The BoE is also under pressure, as other central banks such as the ECB and Federal Reserve have announced that they will begin unwinding their financial support. If the BoE does not act in the same timeline, Sterling could fall, pushing inflation and prices higher. A rising pound will push the cost of imports lower and will act as a deflationary force.

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The pound was lower on Wednesday after investors became less confident about an earlier rate hike by the Bank of England, which is now likely to be delayed due to weak economic data. A weak US dollar and a stronger risk sentiment following news that Evergrande would repay a yuan-denominated bond on Thursday have not helped to support the pound.

Risks for the pound

The main event for the pound this week is Thursday’s Bank of England decision, and investors seem to have moved from expecting a hawkish BoE to grasping the fact that an interest rate hike is now more than six-months away due to the release of disappointing economic data. The currency market is expecting at least two rate hikes by the end of 2022, but now such expectations are considered too optimistic. With the market pricing the fact of an earlier interest rate for some time now, the realisation that the tables have turned, and a rate hike might take a while longer, means that the pound could react by falling. Sterling could find support if the BoE clarifies its timeline for raising rates starting early next year, but this is unlikely, analysts have noted. The Bank’s expectations will also be shaped by the health of the labour market, especially after the furlough scheme is completed at the end of this month, and analysts expect unemployment to rise. The BoE will also take into account disappointing data for July, retail sales’ numbers in August, and high inflation.

The pound was also weaker against the euro as investors are waiting to hear form the Federal Reserve any hints on the direction it will take for its future policy, including whether it will start tapering its bond buying by November.

Factors that could support the pound

The possibility of Britain joining the North American free trade deal, an idea that has been shared by media, could boost UK-US trade and help offer support to Sterling. As a UK government figure said, the UK is interested in pursuing this option but “The ball is in the US’s court. It takes two to tango.”

The trade partnership between the US, Canada and Mexico, is now a possibility after Boris Johnson failed to secure a bilateral deal with Washington. It appears that a direct free trade agreement (FTA) with the UK is not something that the president Joe Biden will be interested in pursuing and the Prime Minister said that Biden “has a lot of other fish to fry.”

The UK government’s interest in joining the North American deal follows the opening of talks for the UK to become a member of the CPTPP Pacific trade group. The likelihood of Britain joining NAFTA is an attempt to secure a tariff-reduction deal as new barriers have been erected to trade with the EU with Brexit.

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Analysts are positive that the pound will likely continue to strengthen in the coming days and even weeks, after encouraging news that the economy should show strong growth in the third quarter and the Bank of England is considering raising interest rates in early 2022.

Growth is expected to continue

Friday’s disappointing GDP data which showed that the economy grew very little did not affect market sentiment, as economists argued that many of the reasons behind the slowdown were associated with the past including self-isolation rules. August and September GDP numbers are expected to be stronger, confirming expectations that the economy is healthy. Economic thinktank NIESR has forecast that UK growth will have picked up in August and September, due to the domestic tourism and hospitality industries, with September’s growth to rise to 0.8%.  

The pound was higher against both the euro and the US dollar on Monday morning, as markets are confident that the BoE could move faster than both the ECB and Federal Reserve and raise interest rates early next year. This will also depend on positive economic data coming out of the UK and investors will want to see consistently positive news before they become confident about the strength of the UK currency.

On Friday, the pound reached a two-week high, following its previous lows, but fell again after global sentiment was threatened by rekindled fears regarding the troubled relationship between the US and China.

Bank of England and rates

The Bank of England is expected to raise interest rates in the first half of 2022 due to improved economic conditions including growth rates and rising inflation. Economists are concerned that inflation will rise above the Bank’s target and for a longer period of time, which could lead to further interest rate rises. This will help boost the pound too.

The Bank of England appears to be more positive and ready to push interest rates higher than many other central banks such as the Swiss National Bank, the ECB and the Bank of Japan.  Following last week’s Monetary Policy Committee members’ appearance before a Parliamentary sub-committee and the revelation that half of the members are already convinced that the minimum conditions for an interest rate hike have been met, the pound has strengthened.

If the recent uncertainty caused by the rapid spread of the Delta variant of the coronavirus proves to be temporary, then the pound will find further support. Economists are still cautious about the pound considering the return to school and the possibility of more cases. The winter is also a concern, and with the number of high cases continuing, consumer spending could be affected. With or without any new restrictions, activity could still suffer as consumers become more cautious. Bloomberg has also highlighted the ending of several government support programmes this month that could weigh on sentiment.

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