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 might experience some volatility today as the Bank of England delivers its August policy decision and Monetary Policy Report. Analysts expect the pound to rise against both the US dollar and euro. At the same time, with many not expecting any major shifts in the bank’s policy, analysts will focus more on Governor Andrew Bailey’s tone and comments for guidance. If the bank strikes a hawkish tone, then the pound might rise, but if it is dovish, then the pound could fall. In general, the market expects interest rates to rise by the end of August 2022, which could help boost the pound, but if a rate increase is pushed back into 2023 then the pound might react by falling.

Scenario 1: Pound could rise

If there are signs that the Bank of England is moving toward ending its quantitative easing programme by the end of 2021 and raising interest rates in 2022, then the pound will find support.  

A currency strategist at UBS said: "We are likely to be served a more hawkish tone, but it will likely fall short of any policy announcement. Still, with nearly all restrictions now removed and COVID-19 cases falling back in the UK, we continue to believe sterling should outperform against both the dollar and the euro over the coming months.”

Market analysts also feel that if there are dissenting voices in the Monetary Policy Committee, then the pound could rise as the possibility of an earlier-than-expected reduction of the QE programme could happen in future meetings. Some monetary policy committee members have already hinted that they may support an early end to quantitative easing (QE), especially following the rise in UK inflation. That could help offer support to the pound. The Bank of England could also provide more clarity regarding the ways it will seek to slowly reduce its QE programme, which will also be met as a positive sign. If the bank offers a clear signal that it will assess the size of its QE in each meeting or even better intends to conclude it in the autumn, then this will be clearly bullish for Sterling.

Scenario 2: Pound could weaken

If there is any disappointing news from the Bank, then the pound could weaken. While market expectations have been boosted due to hawkish comments by Bank of England members for a reduction of the BoE’s asset purchase programme, these could be subverted, as the Bank might stress more risks ahead and weak market data. For this reason, the BoE might want to wait and see how the labour market performs and if wage growth is sustainable before they make any rush decisions. This is why the Bank might strike a more cautious tone, as they would like to see more data assessing the status of the economy, especially after the end of the government's furlough scheme in September. Some analysts expect a more hawkish tone in February 2022 when economic activity is expected to be back to normal.

If you are a business transferring funds overseas, contacting a currency specialist could save you time and money. Get in touch with Universal Partners FX and their dedicated team to discuss the latest market movements ahead of your currency exchange. If you are transferring funds to pay your employees abroad, get in touch with Universal Partners FX to find out how much you can save in your international money transfers. Universal Partners FX can provide invaluable help on efficient risk management and tailored solutions to your business’ transfer needs.