BoE To Keep Hiking, For Now

<div><img width="750" height="430" src="https://assets.iorbex.com/blog/wp-content/uploads/2023/08/01103350/Fundamental-17.png" class="attachment-post-thumbnail size-post-thumbnail wp-post-image" alt="" decoding="async" loading="lazy" srcset="https://assets.iorbex.com/blog/wp-content/uploads/2023/08/01103350/Fundamental-17.png 750w, https://assets.iorbex.com/blog/wp-content/uploads/2023/08/01103350/Fundamental-17-300×172.png 300w" sizes="(max-width: 750px) 100vw, 750px" /></div><p>Last week, the Fed and the ECB left the impression that the rate hiking cycle was at or very close to ending. The optimism in equity markets corresponded with a drop in the respective currencies. By contrast, the BOE is expected to keep hiking when it meets later this week. There is even the possibility it will go for another 50bps hike to bring down the highest inflation in the G7 at the moment.</p>
<h2>The underlying dynamics</h2>
<p>While the BOE has finally gotten around to hike aggressively, the pound hasn’t been able to get the full benefit of higher rates. This is because inflation remains so high, and is expected to stay high, the BOE’s optimism in that regard notwithstanding. Therefore, real interest rates are still effectively in the negative, compared to the US, where real rates have turned positive.</p>
<p>Real rates are the difference between the interest rate and the inflation rate, which translates into the real rate of return on an investment. Effectively, buying UK bonds at the moment means losing value. Meanwhile, buying US Treasuries means making money. It’s no surprise, therefore, that the dollar can remain strong compared to the pound as investors want to make money.</p>
<h2>Convincing the market</h2>
<p>Raising rates helps close this gap, naturally. But it also raises the chance of a recession, which raises the risk premium for the bonds as well. That can offset some of the increased value of the pound as the BOE keeps rising in the face of poor economic indicators. The UK only managed 0.2% GDP growth in the first quarter and is expected to fall into negative for the second.</p>
<p>That might be better than the nil economic growth in the EU for the first quarter. But the future is what matters. The EuroZone is expected to see growth in Q2, while the UK sees a contraction. And the ECB is expected to stop tightening, while the BOE is expected to be forced to keep tightening. All of that might translate into investors not being particularly interested in pound-denominated debt even if rates are hiked, producing a “rejection” weakness in the pound after the meeting.</p>
<h2>It’s all a bit uncertain</h2>
<p><strong>The consensus among economists is that there will be a quarter of a point hike. </strong>That’s reflected in the pricing of the money markets. But major banks like Goldman Sachs and HSBC are warning that there could be a surprise hike of 50bps. But they also warned that this raises the risk of “overkill”, substantially increasing the risk of a recession unless there is something to prevent the rise in peak rate expectations.</p>
<p>The current rate is 5.0%, with the consensus being that it will rise to 5.25% after the meeting. That would put it 50bps short of the peak rate expectation of 5.75%. But if the BOE does more than a quarter of a point hike, the markets could move to price in a terminal rate above 6.00%. This creates the potential for volatility, as an initial move to the upside could fade fast due to worries over the outlook for the economy. But if the BOE isn’t hawkish enough in its statement, it could also weigh on the pound given the 50bps disappointment.</p>
<p>The post <a rel="nofollow" href="https://www.orbex.com/blog/en/2023/08/boe-to-keep-hiking-for-now">BoE To Keep Hiking, For Now</a> appeared first on <a rel="nofollow" href="https://orbex.com/blog/en">Orbex Forex Trading Blog</a>.</p>