FX Trading focus: Bank of England will struggle for relevance today. Watching for sterling turn lower.
The Bank of England is priced at over 80% odds to hike another 50 basis points at today’s meeting, with two further 50 basis point hikes half-heartedly priced for the following two meetings (market price for a total of 129 basis points through the next three meetings – 45 for today’s, 46 additional for Sep. and 38 more for the Nov. meeting). A couple of dovish dissenting voices are likely on concerns that the UK is headed into a recession and that accelerating the policy tightening is not the right medicine, while Governor Bailey seems happy to signal that concern while throwing up his hands at the lack of alternatives, given forecasts that inflation is set to reach above 10% in Q4. Besides any language that shifts the market’s lean on the size of future rate increases, watch for the indirect implications of any change to forecasts for economy (will the BoE explicitly forecast a recession and are inflation forecasts of sub-2% levels by 2024 maintained) as well as the signaling on reducing the balance sheet (the plan is supposedly for a £50-100 billion annual pace starting possibly after a vote in September). The event risk outcome from this BoE meeting run from indifference to slightly upside risk and somewhat larger downside risk for sterling. Have a hard time seeing the BoE coming with a significant hawkish upgrade relative to market expectations. Supposedly, forecast adjustments on inflation could see the market adjusting rate tightening expectations higher, but how likely is that as energy prices are below where they were at the BoE’s May forecasts and the BoE is likely looking for excuses to sit on its hands and await incoming data – a la the Powell Fed – as clouds gather on the horizon?
Sterling has traded firmly against the single currency since mid-June, largely in line with the Bank of England bolstering its hawkish credentials as it signaled the intent to hike more at coming meetings to counter the inflation threat. Today’s Bank of England is an interesting test of the Bank’s relevance and sterling, particularly in this most important of sterling pairs. Both the UK and the continent are in similar boats with a galloping energy crisis, but with the UK facing far more isolation and worse external deficits if the prospects for the winter darken, although the EU has the unique angle of a possible new existential crisis brewing in the wake of the Italian election – so far not priced with much fear in the options market. There is a bit of range left to work with down to 0.8200-50, while a reversal back above 0.8450 suggests this recent period of sterling out-performance is behind us should the Bank of England fail to gain more credibility on its guidance and balance sheet reduction plans.