Despite Sterling rising yesterday following the Bank of England’s positive tone and the prospect of an early rate hike in 2022, on Friday it fell.
Asian and European stock markets were also down on Friday as well as risk-oriented currencies as the potential default of Evergrande can have significant repercussions on markets.
Pound and BoE
After the Bank of England’s meeting on Thursday, markets have brought their expectations forward as now the BoE is expected to start a rate hike cycle with a first increase in May 2022, followed by a second one in November 2022. While there are still uncertainties ahead for the pound, the British currency is still forecast to strengthen against the US dollar and the euro over the medium-term, as some analysts believe.
Rate hike expected in early 2022
With markets now pricing in the first rate in the first quarter of 2022, the pound will find support, despite questions about the country’s economic recovery. Challenges will continue to exist, including unemployment and labour shortages that have become more prominent due to Brexit. Some analysts believe that if unemployment does not rise then the Bank’s Monetary Policy Committee could even add a small rate hike as soon as February. With market expectations for a rate hike already priced in, it is likely that the Bank will have to raise rates in early 2022 as it could otherwise create confusion and push the pound lower. For example, big banks such as JP Morgan have brought their expectations forward for a rate rise in early 2022 following the Bank’s announcement yesterday. Capital Economics said: "The Bank is moving closer to raising interest rates. As such, we now think that rates could rise in early 2022, rather than in 2023 as we had previously thought." They also added: "Given the gloomy tone of the recent news on economic activity, we had expected the MPC to place some weight on the downside risks to GDP growth.” However, the Bank’s minutes stressed price stability and the inflation target which remains the same. The Bank highlighted that growth uncertainties were external and depended on global supply chain limitations.
For Sterling, any news about when the rate hikes will start or the vote on QE will be key. Both Dave Ramsden and Michael Saunders voted to lower the purchase rate to £840bn instead of the £875bn. The fact that two policymakers want to tighten the policy is important.
Earlier interest rate hikes will offer more support to pound
With interest rate expectations and a first rate to take place for Q1 next year, the pound is expected to find support. It could rise even further if such expectations move even more forward. While raising interest rates might not affect inflation, what other Central Banks do does have an effect on global markets and policy. The ECB and the Federal Reserve have both announced that they will begin the tapering and reduce their stimulus support, and if the Bank of England does not follow suit the pound could go lower, something that could push inflation to rise and import prices to go higher.
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