The pound remains strong and is close to last week’s gains against both the euro and the US dollar following Bank of England Governor Andrew Bailey’s comment that the bank is intent on raising interest rates as inflation risks rise.

Many analysts have noted the benefits of an early rate hike, while others have warned about the impact of an early rate hike on UK growth prospects. According to foreign exchange analysts, the pound has found support from expectations that the Bank of England will be among the first major central banks to raise interest rates since the pandemic started.

Bank of England

Bank of England Governor Andrew Bailey said on Sunday the Bank of England intends to raise interest rates if inflation continues to grow. Speaking to the Group of 30, an international body of financial leaders, Bailey explained that UK inflation will be temporary, but rising energy prices will push it higher and for a longer period of time. Bailey said: "Monetary policy cannot solve supply-side problems - but it will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations.” He also clearly stated: "We at the Bank of England have signalled, and this is another such signal, that we will have to act. But of course that action comes in our monetary policy meetings."

Some analysts believe that the shift in monetary policy will outweigh the negative effects of slow economic growth and will slowly push the pound higher.

Rabobank: Risks Ahead

The prospect of the pound rising next year and beyond could be hindered by fears around the medium-term outlook for the UK economy. Rabobank said: “Tensions with French fishermen and disagreements about the Northern Ireland protocol have brought warnings of a trade war between the UK and the EU. Neither had had a significant impact on the pound to date. That said, this is a risk that the differences between the UK and the EU won’t be resolved easily and, on the margin, this news-flow provides an additional disincentive to GBP investors.” They added: “We are not expecting the BoE to raise rates in the coming months and see scope for GBP to edge lower on disappointment.”

Next Interest Rate Rise

Money markets are now expecting a rate rise in November, and as many as three rate hikes in 2022. If the Bank disappoints and does not proceed to a rate rise, the pound will fall. At the same time, other analysts have talked of a Bank of England policy mistake as they believe raising interest rates would slow down growth. A more aggressive BoE tightening will push borrowing costs for households and businesses higher and will impact the UK housing market. Stagflation (no growth and high inflation) fears will add to concerns about the pound.

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