Markets are expecting the Bank of England’s interest rate decision today at midday and economists have warned that unless the Old Lady of Threadneedle street sounds hawkish and hikes by at least 50 basis points, the pound could fall.

The foreign exchange markets are expecting a higher than a 25-basis point rise, as UK inflation has risen at 9.0% and could reach double digits later in the year. Additionally, the BoE needs to take into account other central banks which are raising interest rates higher. It has been noted that the currencies of those countries whose Central Banks have been slower to hike interest rates tend to underperform, whereas currencies such as the US dollar tend to rise when the Central Banks show a clear intent to hike interest rates faster and higher.

Analysts have noted that the Bank of England will need to defend Sterling and thus it will need to act accordingly and in a similar manner as the Federal Reserve which hiked interest rates on Wednesday by 75 basis points. Some analysts expect a rate hike by the Bank of England as high as 75 basis points in order to ensure that the pound strengthens, especially after falling to multi-year lows this week.

Conall MacCoille, chief economist at wealth managers Davy, has said that there is a strong case for the BoE to raise interest rates by as much as 50bps: “CPI inflation at 9% and a tight labour market are creating a risk that employee price expectations could become entrenched.”

Central Banks to raise rates aggressively

Former governor of the Bank of England Mark Carney has said in an interview with Bloomberg TV yesterday that “Central bankers need to catch up to their economies. They’ve been behind the curve, they’ve acknowledged this. And they need to start to get interest rates above inflation effectively, or at least inflation expectations.”

He added: “If you’re far behind, it does make sense to front-load.” Carney argued that central banks should front-load interest rate rises as they need to tackle rising inflation while supporting economic recovery.

Members of the BoE’s MPC have expressed similar views, but the MPC as a whole is rather dovish and traditionally is cautious and prefers to keep rates unchanged or deliver smaller rate increases.

Pound to fall if BoE is cautious

If the BoE signals an end to its hiking cycle, then the pound will weaken, as some economists have warned. Others believe that the pound’s performance will depend on the BoE’s commentary and domestic data in the coming months and that any further raise in interest rates will not provide much support. Most analysts believe that a 25 or 50-basis points rate hike will not lift the pound and that a bigger move will be necessary.

With the UK’s expected economic slowdown and inflation falling eventually, some of the Bank of England's MPC members would argue that raising interest rates would hurt growth.

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