The pound has dropped against the euro and the US dollar ahead of Thursday's Bank of England policy meeting as investors have begun readjusting their positions.

The Bank of England will deliver its latest policy decision alongside the quarterly Monetary Policy Report and expectations for a rate rise are high.

The pound has appreciated over recent weeks on expectations that the Bank of England will push the bank rate higher by 15 basis points to 0.25%. However, the drop at the beginning of the week suggests that markets are divided about the Bank of England’s interest rate decision, as many are now expecting a delay to the rate hike or a more cautious tone from the bank.

Bank of England interest rate hike

ING economists expect a 15bp rate hike, but they believe the bank will remain cautious, as they may lower their medium-term inflation forecasts and remain divided about a rate hike. Any surprising move by the bank will push the pound lower. While members of the Bank have highlighted the need to act as inflationary pressures rise, the likelihood of a November hike has now fallen while the likelihood of a December rise has risen. This has affected the pound, which has underperformed the last few days.

The Chicago Mercantile Exchange’s measure of interest rate futures, known as BoE Watch, has noted that the possibility of a rate rise in the UK this week is 100%.

Confusion among investors

Contradictory data has confused investors over which direction the central bank will go. Financial markets show that many investors are anticipating a hike, while City economists expect rates to remain at historic lows. The views of economists are in line with MPC members Silvana Tenreyro and Catherine Mann, who have warned that an interest rate rise could threaten economic recovery which is already slowing down.

Governor Andrew Bailey, chief economist at the Bank of England Huw Pill and former Citibank economist Michael Saunders, have all highlighted the importance of acting to control inflation. Bailey has characteristically stated that the bank “will have to act and must do so if we see a risk, particularly to medium-term inflation.” Deputy governor Sir Dave Ramsden is also one of the hawkish members and supports raising rates from their historic lows. If four members of the committee are in favour of higher rates, then one more member is needed to succeed. It will be interesting to see what Deputy governor, Ben Broadbent, will vote as he has never gone against the governor in his seven years on the Monetary Policy Committee.

Deutsche bank economists also believe that the BoE would deliver its first rate hike of 0.15% and that the MPC will end its QE programme a month earlier by cutting £20bn from QE.

Others have noted that Bailey would want to avoid disappointing markets, even though a rate hike was yet not a solid reality.

The confusion about what decision the Bank will make on Thursday’s meeting is largely related to the wide range of contradictory views by various analysts and economists.


Pound reaction

Sterling’s performance will also depend on the inflation forecasts of the Bank's Monetary Policy Report.

If the Bank proceeds to raise rates twice, the Bank Rate will go up to 0.50% over the next 3 months, which will boost the pound.

Markets expect a number of rate hikes in 2022 which would take the Bank Rate to 1.00%, but economists have noted that they will be disappointed.

Whatever the pound’s reaction ahead of Thursday, it will set the tone in the following days, so if it remains under pressure then markets might turn pessimistic.

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