Thursday's Bank of England policy meeting is expected to create volatility for the pound due to uncertainty as markets do not expect a rate hike, but the Bank could still deliver a “hawkish” surprise. The IMF has said that the time to hike is now but any justification for a rate hike delay would be attributed to the emergence of the Omicron variant and further government restrictions to control its spread.

Market expectations

The market now expects the Bank rate to remain the same at 0.10%. Any surprises from the Bank or solid guidance to quickly push interest rates higher once the Omicron wave has passed in 2022 could push the pound higher. Bank of America and other analysts expect the Bank to keep rates unchanged and signal an interest rate rise in February.

While analysts believe that under other circumstances the Bank of England (BoE) would have hiked rates, the Bank still needs to wait and see as the current uncertainty brought by the Omicron variant could have serious repercussions on the economy with possibly more restrictions coming in the weeks ahead. According to insiders, the furlough scheme which ended in September could be brought back if new restrictions are put in place because of Omicron.

While a small hike could be possible, the foreign exchange market is now expecting rates to be left unchanged. Fading expectations for a rate hike this December were responsible for the weakness in the pound in recent weeks.

The pound and uncertainty about an interest rate hike

For many analysts, there is still much uncertainty about the Bank’s impending decision. If the market has some lingering expectation for a rate hike, then keeping interest rates the same could weaken the pound.

According to Bank of America, there are a number of factors that could hurt the pound as we move into 2022. A rate hike will clearly support the pound, and there are still analysts who believe this scenario. They believe that by Thursday (16 December), the Bank will have sufficient information for a 15bp hike, such as tight labour market conditions. Data from the ONS has shown that the end of the furlough scheme has not resulted in a spike of unemployment and many people on furlough returned to their jobs. The recent news of low unemployment, robust wage growth and increased number of vacancies provide a clear picture of a strong labour market. But some members of the MPC could highlight that the number of jobs and hours worked is still below pre-pandemic levels.

In their assessment of the UK economy, the IMF said that monetary policy needs to withdraw the financial support that was offered during the pandemic in 2020. They expect the Bank rate to remain unchanged, but they believe there will be a clear direction towards raising interest rates rapidly thereafter.

Analysts have noted that the risks for the pound are limited, if an interest rate rise is not announced on the 16th of December. They will be focussing on comments by policymakers and on the meeting’s minutes regarding the reasons for delaying monetary policy tightening.

The pound could gain support if there are strong signals that the Bank will proceed to a number of rate hikes at a later stage, if the costs of the new variant are seen as limited.

While the timing of the first rate hike has now changed and markets expect this to take place in February 2022, analysts at Barclays remain positive and see the pound to appreciate in 2022, supported by the BoE’s tightening, higher inflation and an increased number of inbound mergers and acquisitions.

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