Published: November 3rd, 2021
Sterling finds itself on the back foot at mid-week (3rd November) against the greenback, euro, and a list of other G10 majors. Analysts say it could be a sign investors are adjusting expectations in advance of Thursday's Bank of England (BoE) policy meeting.
Threadneedle Street will make its latest policy pronouncement, along with the scheduled quarterly Monetary Policy Report. Markets appear to think it's now odds-on for a rate rise.
Over the past few weeks, expectations have grown that the BoE will raise the Bank Rate to 0.25 per cent, a 15 basis point rise. As consensus has solidified its helped the pound appreciate.
The steady drops seen this week, however, suggest that investors are now anticipating that the rate hike may wait, and that the bank will provide cautious guidance.
ING Bank’s London research unit said in a note to investors that the pound ‘has started to underperform a bit. From our perspective, it seems investors are beginning to re-set positions ahead of Thursday's bank meeting.’
ING economists believe a 15bp rate hike announcement is possible tomorrow (Thursday, 4th November) given the hawkish comments some members of the Bank's Monetary Policy Committee (MPC) have made recently.
But they do think the market may be exaggerating the scale of future tightening and expect to see some resistance from policymakers in the form of a split vote on the rate hike and a lower medium-term inflation forecast.
Under that scenario, where a central bank underdelivers on 'hawkish' market expectations, the fiat in question would typically weaken.
ING is also looking for dollar (USD) strength this week since the Federal Reserve will issue its own policy decision, which could see the GBP/USD exchange rate continue its recent pullback.
GBP/USD movements will also be influenced by how the EUR/USD trade.
‘We believe that the trends in terms of how EUR/USD trades at the 1.1500 level will determine whether it needs to drop further,’ says ING.
Faced with heating-up inflation, the BoE’s Monetary Policy Committee has said rates will soon need to rise in order to manage inflation expectations amongst consumers and businesses.
FX Strategists at Swedbank told investors in a note this week that ‘We would be very surprised if the Bank of England did not decide to raise rates on Thursday.
GBP will undoubtedly take a hit if that happens. For us, it's more a question of how much of a rate hike the bank believes is consistent with its two-year inflation target.’
I that’s the case, the inflation forecasts contained in the Bank's Monetary Policy Report could define how the fund finishes the week.
Swedbank says it expects at least two rate hikes will be announced, which would move the Bank Rate back to 0.50 per cent over the next three months.
‘That could be enough to give sterling a near-term boost against the euro’.
If it does decide to raise rates, the move would be consistent with the bank's role in maintaining price stability across the economy.
It’s worth noting, however, that money market pricing suggests the likelihood of a November hike have fallen over the last week while the probability of a December hike has increased.
That could explain in part why sterling has come under pressure this week.
Economist expectations, however, are split. Bloomberg's recent survey of institutional analysts shows 13 out of 29 still expect rate rise announcement tomorrow.
Economists at TD Securities told Bloomberg that ‘a 5-4 vote to keep rates at their current levels could happen, and we believe that outcome would be driven by the committee’s middle-ground members wanting to see more post-furlough labour market data before moving forward with a rate rise.'
TD Securities says its approach is to fade GBP/USD ahead of the pair’s 200-day moving average, with the potential to reload on breaks of 1.35. EUR/GBP, meanwhile, remains a sell on rallies ahead of the 0.86 level.
Current market pricing indicates several rate hikes are expected next year, which could move the Bank Rate back up to 1.00 per cent, establishing a new high for the post-financial crisis era.
Swedbank’s view is that this stance is ‘unrealistically aggressive’, and forex traders who follow it are setting themselves up for disappointment.
‘We are sceptical that the BOE will lift rates to the extent being currently priced in.’
Forex analysts at Goldman Sachs, meanwhile, are telling clients they are 'bearish' on sterling’s near-term prospects and believe the Bank of England will disappoint markets tomorrow.
‘This months MPC meeting could be where the 'rubber meets the road' for the bank’s approach to inflation, and markets have arguably set the bar too high for the MPC to deliver. Pricing in a full fifteen basis-point rise for this meeting, and nearly sixty basis points cumulatively through February, is just not realistic in our view.’
Goldman’s analysts say it will be tough for the BoE to significantly over-deliver at this stage, leaving room for disappointment if the policy committee points markets towards a more tepid pace.
That ‘tepid’ pace would result in a 15bp rise in November, followed by a 25bp hike in February.
‘That skews the risks for GBP to the downside in the near term,’ says Goldman.
Price action around central bank policy events is often driven by the old adage 'buy the rumour, sell the fact.’
Whatever direction markets decide to take the pound in the immediate aftermath of tomorrow’s BoE announcement, it could see a reversal as the week’s session continues.
Goldman believes that if the sterling stays under pressure leading into the event itself, then investors may be re-positioning too negatively, setting the bar for a 'hawkish' surprise and a rebound fairly low.