Bank of England governor Andrew Bailey gave the clearest message yet that the UK’s central bank was poised to raise interest rates later this year after saying it “will have to act” to ease inflation expectations.
Despite the clear signal from Bailey, speaking online at a G30 international banking seminar on Sunday, the pound was unmoved against its major rivals as investors appeared to have already fully priced in the first rate hike from the bank before the end of the year.
Raised rate expectations
Yet the pound has been rallying this month on raised expectations that the bank will start its tightening cycle sooner than was previously expected as energy prices and higher raw materials costs coupled with supply chain constraints have pushed inflation well beyond the bank’s 2% target rate.
Having started October at around $1.34 versus the dollar, the pound stood at $1.3744 in early London trade on Monday – up 2.6% on the month. Over the same period, the euro has lost 2.6% against the pound to £0.8433.
On Sunday, governor Bailey said that while he still believed the rise inflation – to a headline rate of 3.2% in August – would still prove temporary, he admitted that the rate-setting Monetary Policy Committee (MPC) was increasingly concerned over inflation expectations becoming embedded.
“That is why we have signalled – and this is another such signal – that we will have to act,” Bailey said.
Earlier rise appropriate, says Saunders
Previous signals have been iterated by other MPC members, most notably by MPC member Michael Saunders who, a week ago, said: “Markets have priced in over the last few months an earlier rise in the bank rate than previously, and I think that’s appropriate.”
Central bankers are increasingly worried that current higher rates of inflation lead to rising inflation expectations, as consumers are apt to feed this cycle by purchasing in larger volumes now because they expect prices to rise in the future – thus perpetuating the inflationary trend.
“Bailey is clearly in the camp looking to prevent high current inflation seeping into inflation expectations,” said Francesco Pesole, FX strategist at ING.
He added: “The market is moving to price earlier and more aggressive tightening cycles, leaving bond markets under pressure and the currencies of central bank first-responders bid.”