Bank of England downs the pound

A third consecutive rate hike by the Bank of England sent the pound tumbling against the dollar, before recovering most of the losses later in the day. Plenty of volatility but not much direction!

Let’s take a look a closer look at the reaction in GBPUSD:

The big red candle is cable falling 100 pips from 1.32. As traders digested the news, the price stabilised, posted a new low of 1.3087 and then retraced the majority of the move through the afternoon session.

Zooming out to the daily chart, price now sits right on a key resistance level,although still a way below the 20, 50 & 200 day moving averages.

What did the Bank of England do?

First up, they hiked rates by 0.25% (to 0.75%) as expected. The benchmark interest rate has now returned to the pre-pandemic level. There was a slight surprise in the votes though. A unanimous decision was expected, but Governor Cunliffe dissented and voted to keep rates on hold.

The majority of the Monetary Policy Committee (MPC) voted in favour of the rate hike (8-1) because of the continued tightness in the labour market, current inflationary pressures, and worries that these pressures will persist.

All of which seems entirely justified. The MPC previously forecast inflation to peak at 7.25% in April. They now see inflation rising to “around 8%” in Q2 and warned that prices could peak at even higher levels later this year.

If inflation is set to increase, why did Governor Cunliffe dissent?

He focused on "the very material negative impacts of higher commodity prices on real household incomes and activity". Basically, economist lingo for “higher energy bills and commodity prices will make people feel poorer and leave them with less money to spend on non-essentials”.

The central bank also expects economic growth to slow, partly due to the Ukraine invasion: “Global inflationary pressures will strengthen considerably further over coming months, while growth in economies that are net energy importers, including the United Kingdom, is likely to slow.”

And the real kicker? Although Cunliffe was a lone voter this time, his view is seemingly shared by the committee, likely influencing their expectations for further rate hikes.

Last month the MPC said further modest tightening "is likely to be appropriate".

At yesterday’s announcement “likely” was downgraded…

"The Committee judged that some further modest tightening might be appropriate in the coming months, but there were risks on both sides of that judgement depending on how medium-term prospects evolved,"

These subtle shifts in language can have a big impact. Overnight index swaps (OIS) indicated investors drastically lowering their interest rate expectations.

As Pantheon Economics’ Samuel Tombs noted:

“Today's 16bp day-on-day drop in expectations for Bank Rate in six months time is the 2nd largest since 2009 (as far back as OIS data go). Only in Nov 2021, when the MPC didn't hike, has the drop been bigger.”

There’s an intriguing divergence between the Fed and the BOE now. One is just starting their hiking cycle, with Fed chair Powell touting the “very strong economy”, while the BOE is casting doubt on the economy being able to withstand a series of interest rate rises…

Not investment advice. Past performance does not guarantee or predict future performance.