Is the BoE about to let the fireworks off before Guy Fawkes?

It’s a big week for markets as we have lots of event risk to inject some volatility (options market implying just shy of 1% price move for the pound on Thursday). Our Head of Research Chris Weston has written a good piece on all of them here. In this article I’ll be focusing on the Bank of England Meeting this Thursday (12pm GMT).

Over the last month or so money markets have aggressively repriced short term rates higher globally, but the UK has been particularly aggressive. Markets are pricing 13bps for this Thursday (87% probability of a hike), just below a 15bps hike. Additionally, a 100bps of tightening is priced by the end of next year, which seems excessive. From the new guidance, we know that this would trigger the sale of gilts and the unwinding of their balance sheet, which would be very hawkish alongside rate hikes. The BoE will acknowledge that rates will need to move higher in 2022, but I think they will push back against the very punchy 100bps (quell fears of a policy mistake). One way to do this is through their inflation forecast – if it’s below 2% (target) at the end of their forecast horizon. Will it be enough to blunt money markets from pushing rates higher though? Speaking of forecasts, growth will be revised lower on the back of supply chain problems and higher energy prices. Inflation will be upgraded in the short term with a potential peak of around 4.5% and then begin to decline further out, indicating the transitory expectation by the BoE. High frequency data on vacancies and redundancies point to a minor improvement on the unemployment forecasts.

Until recent hawkish rhetoric from Governor Bailey – “must act” and Chief Economist Pill – “November will be a live meeting”, markets had been expecting a hike only by December due to data on the effects of winding up the furlough scheme only becoming available by then. However, inflationary pressures are obviously causing some concerns over at Threadneedle Street and could galvanize action this Thursday. I think they see a rate hike as an insurance policy to prevent inflation expectations from becoming unanchored. How effective it is at combatting surging inflation expectations is the other question, given monetary policy is best suited towards demand-pull inflation as opposed to the causes of UK inflation – supply chain dislocations, wages and gas prices (cost-push inflation). I lean towards a 15bps hike at this meeting with a 5-4 vote in favour. Additionally, looking at previous precedent the BoE usually take action alongside the release of monetary policy reports which is what we have at the November Meeting. However, because this is basically baked into the price, I would say the risk is for sterling to weaken if they decided rather to hold and we see some dovish repricing in money markets. Furthermore, sitting on their hands creates credibility issues as the BoE has done nothing to push back against the market’s pricing, in fact I’d say they’ve encouraged it. I highly doubt Governor Bailey wants to earn the nickname of the “unreliable boyfriend” as previous Governor Mark Carney did.

GBPUSD:

(Source: TradingView - Past performance is not indicative of future performance.)

Cable is trapped in a tight range with this week's BoE meeting likely to be the catalyst to cause some price vol. The 21-day EMA has ever so slightly crossed below the 50-day SMA. The RSI as I noted previously struggled to sustainably remain above 60 as we have seen on previous rallies and is now back in the high 40s region. Targets - 1.385 (horizontal resistance and 200-day SMA) on the upside. While on the downside, monitor the 1.366-1.36 level.

EURGBP:

(Source: TradingView - Past performance is not indicative of future performance.)

EURGBP continues to fluctuate between the 0.845 and 0.85 level with temporary overshoots tending to be capped by the 21-day EMA. The RSI is back just above the 50 level. The meeting on Thursday if dovish could see EURGBP moving towards the 0.85 level with the 50-day SMA slightly above (0.852). On the downside, look towards the 0.845-0.84 support.