The pound rose in response to Bank of England Governor Andrew Bailey’s comments that a 2022 rate hike is possible. While soon after, the pound was unable to hold its gains, the revelation by the central bank was important as it confirmed market expectations that a rate rise in the first half of 2022 is possible.
UK tax hike
The pound was higher, especially after it lost ground due to an announcement on Tuesday of a UK tax hike. The proposal, which on Wednesday was backed by British lawmakers in a parliamentary vote, intends to raise taxes to fund the health and social care systems. The government will raise the rate of National Insurance payroll taxes paid by both workers and companies by 1.25 percentage points. The tax on shareholder dividends will also rise by the same percentage. The plan is expected to help raise 12 billion pounds ($17 billion) a year.
Bank of England Vote to Raise Interest Rates
Andrew Bailey clarified that the eight members of the Monetary Policy Committee (MPC) were divided as to whether the UK economy was healthy enough for interest rates to be raised. In a testimony to the Treasury Select Committee of the House of Commons, Bailey noted that the vote was split: “Let me condition this by the fact that it was an unusual meeting because there were only eight members of the committee - so it actually was four-all.” In the August MPC meeting, however, all 8 members voted to keep interest rates unchanged. So, the bank feels more confident about the state of the economy now. Nonetheless, Bailey explained that the
Bailey said that the conditions were not yet sufficient. Markets expect the MPC to end quantitative easing in December before proceeding to raise interest rates. While Silvana Tenreyro did not believe that the conditions have been met yet, other members of the MPC including Bailey, Dave Ramsden and Ben Broadbent and Michael Saunders, all believed that the minimum conditions had been met for a hike. The remaining members of the MPC, Gertjan Vlieghe, Jon Cunliffe and Jonathan Haskel were possibly the more dovish members who believe that conditions have not been met yet.
Has the 2022 interest rate already been priced in by markets?
It would appear that it has been priced in by markets, as the pound was unable to hold gains. For the pound to strengthen, the Bank will need to provide more evidence of future rate hikes. If inflation stays above the Bank’s 2.0 % target, then the need to raise interest rates will rise too. The Bank’s economists expect inflation to rise 4.0% in 2021 but fall back in 2022. Bailey said that some issues could disappear, but unemployment and job vacancy issues could persist. Higher commodity prices and problems with supply chains could go away, but the labour market will need to improve consistently.
Economists are concerned that after the end of the government's furlough scheme, unemployment will rise. But with many businesses finding it difficult to fill in their vacancies, the end of the support program might be positive.
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