The Bank of England (BoE) has defied market expectations by raising interest rates 50bps at their September meeting. Implied pricing showed that market participants were skewed towards a bigger 75bps hike, especially after BOE Governor Andrew Bailey had used the term “forcefully” when referring to the BoE’’s need to combat high and persistent inflation at the previous meeting. This word, in fact, has also been repeated in this week’s statement, but still the bank has deemed that 50bps is enough.
Actually, no. The BoE as a whole doesn’t see it that way. Three of the nine voting members have lobbied for 75bps at this meeting, but they lost out to the majority. These members were of course the ones perceived to be more hawkish, Ramsden, Haskel, and Mann, which is no surprise. Another member voted for a smaller 25bps hike which is slightly surprising and may have confused markets given the current levels of inflation.
In fact, the updated projections from the BoE suggest inflation peaking at 11% in October, which is a drop from the 13.3% predicted at the meeting in August, but nonetheless it suggests CPI may continue to rise over the coming months. The fact the BoE assumes inflation may remain above 10% for the foreseeable future, and yet they continue on their cautionary path of rate hikes, is what might fuel the continued sell-off in the British Pound (GBP).
This is because the UK economy is at a greater risk of stagflation than the US. This term defines a period of high inflation and stagnant growth, and with the BoE predicting a recession over the next 5 quarters, the projected rate of inflation implies the UK economy could be in for some turmoil up ahead.
Compare this to the US, where there is also persistent high inflation, but the Federal Reserve has been acting more forcefully to combat this issue. This alone gives the US dollar a competitive advantage against the Pound. Add on to that the fact that market sentiment is worsening given the escalation in tensions in Eastern Europe and you get further demand for the dollar as a safe-haven asset.
For now, GBP/USD is holding above this week’s lows but the technical setup suggests further downside pressure to come, with a firm focus on the historical lows for the pair around 1.0512, last seen in 1985.
Markets may start to evidence that the three BoE dissidents are right and the Bank could have put their foot down even harder on the hiking pedal. Unless of course, concerns about the looming recession become more important than inflation, at which point the gradual rate hikes the BoE has been delivering make more sense— and might mean the Pound is in a better position for recovery than its major counterparts. Only the upcoming data may be able to shed some light on which side of the spectrum market participants will fall.
This commentary first appeared in Investing.com.