The pound has been lifted from its lows after the Bank of England disappointed markets by keeping interest rates unchanged. On Tuesday, the pound was higher as investors are now focusing on a February rate rise.
While speaking at a virtual event organised by the Bank of England (BoE), Governor Andrew Bailey stressed that they will have to act and raise rates if they see a clear indication that higher inflation is feeding into wages. His comments did not impact on the market pricing of a rate hike in December. The CME Group's BoE Watch Tool shows a 67.5% chance of a 20-basis points rate hike before the end of the year.
In terms of Brexit, the ball is now in the UK’s court. After the EU clarified that they will act accordingly if Britain were to trigger Article 16, they are now waiting for the UK to make the next move.
Economic growth and Bank of England
The Bank of England’s dovish turn and less aggressive policy is in line with market data and suggests that their interest rate decision was made based on a more restrained and conservative economic growth outlook. The Bank lowered its 2021 growth forecast to 6.7% from August’s 8.5% forecast but raised the 2022 GDP forecast from 2.3% to 2.9%. 2023's forecast has been lowered to 1.1% from 1.3% that it was previously.
Inflation is expected to go over the 2.0% target in the coming months and the Bank could act by raising interest rates if it deems appropriate. Bank of England Chief Economist Huw Pill said on Friday Nov. 05 that he believes the pace of wage inflation will surpass both those of the Eurozone and the US.
A more measured Bank means that there are less risks for early tightening, especially if inflation proves to be transitory. This will also support economic growth and households which are already struggling with higher costs.
Economists do believe that the Bank of England will still raise interest rates to fight inflation in the near future, as they expect hikes in December and February.
Other possible factors to consider for pound volatility
- As a procyclical currency, the pound goes up when global stock markets are strong and falls when they fall. If the pound weakens it is usually against stronger safe havens such as the US dollar, the yen and the franc. For now, market sentiment is positive, and this has given fresh impetus to the pound.
- Brexit tensions are growing, and this could potentially impact the pound. Ireland’s foreign minister Simon Coveney warned that the EU-UK Trade and Cooperation Agreement could be dismissed if the UK triggers Article 16 and rewrite the protocol on Northern Ireland. The protocol, which is part of the EU-UK withdrawal agreement, was agreed in order to avoid a north-south trade border on the island of Ireland. Protestant Unionist parties have rejected the agreement, and two buses were set on fire in the past week. If the UK fails to maintain a border in the Irish Sea, then this will threaten Ireland’s economic rights as an EU member and it will be unacceptable by the 26 EU member states. Without a border, animal and plant products will enter the EU single market, without full legal controls. Ireland’s goods won’t be trusted, and checks will possibly be required in order to enter the EU. Markets will await any updates on Friday, following the EU and UK's chief negotiators meeting this week.
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